ARTICLEmyweb.fsu.edu/shsu/publications/51HousLR719.pdfto production.1 Among economists, capital is...

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ARTICLE

CAPITAL RIGIDITIES, LATENT EXTERNALITIES

Shi-Ling Hsu*

ABSTRACT

Capital, one of two fundamental inputs to production, is

critical to economic growth. As such, legal rules and institutions

generally seek to create more of it, and they also seek to protect

existing capital from policy changes. However, capital is often

durable, and during its natural life, information may emerge

pointing to negative externalities resulting from operation of that

capital. Legal rules and institutions, in seeking to stimulate and

sustain economic growth by promoting and protecting capital,

thus tend to induce the creation of excess capital. This

abundance of capital creates excess resistance to new regulation

or policy reform, as capital owners will have a larger capital

stake to defend and will expend more resources to resist changes

in their legal and economic environment.

This theory of capital has special application to

environmental externalities, which are commonly latent. Capital

is thus almost always obtained with incomplete information

about potential environmental externalities. Environmental law

is the means by which many previously unforeseen externalities

are sought to be addressed, but any change in environmental law

* Larson Professor of Law, Florida State University College of Law. The Author

gratefully acknowledges the comments of Steve Johnson, Emily Hammond, David Dana,

Michael Barsa, and Alexandra Klass, and the excellent research assistance of Patrick

Walker and Sarah McCalla, and of the outstanding library staff at the Florida State

University College of Law. This Article benefitted greatly from comments from attendees

at the Fourth Annual Meeting of the Society for Environmental Law and Economics, the

2012 Annual Meeting of the International Society for New Institutional Economics, and

the Environmental Colloquium workshop at the Northwestern University School of Law.

This work has been supported by funding from Carbon Management Canada.


720 HOUSTON LAW REVIEW [51:3

is invariably challenged by capital owners. By enacting legal

rules to promote and protect capital, developed societies have

unwittingly erected larger barriers to environmental reform.

Over time, environmental law has become more difficult to

reform and the source of more litigation.

TABLE OF CONTENTS

I. INTRODUCTION ..................................................................... 720

II. WHAT IS CAPITAL? ................................................................ 727

III. HOW CAPITAL IMPEDES REFORM .......................................... 735

A. Overcapitalization as a Drag on Environmental

Reform ........................................................................... 736

B. A Model of How Capital Impedes Reform .................... 739

IV. THE ROLE OF LAW AND LAWMAKING IN PROMOTING AND

PROTECTING CAPITAL ........................................................... 743

A. Tax Benefits for Energy Industries ............................... 744

B. Tax Benefits for Mining Industries ............................... 753

C. Electric Utility Regulation ............................................ 755

D. Grandfathering ............................................................. 760

E. Regulatory Takings Jurisprudence .............................. 764

F. The Politics of Human and Social Capital ................... 768

V. WHITHER, CAPITAL? A REFOCUS ON PUBLIC GOODS ............ 772

VI. CONCLUSION ......................................................................... 778

I. INTRODUCTION

Capital is good. Capital and labor are the two stylized inputs

to production.1 Among economists, capital is universally regarded

1. The Cobb–Douglas production function, which every economics student

learns about in undergraduate economics, posits production as a function of the

quantity and productivity of just two types of inputs: labor and capital. See generally

Gerald Beer, The Cobb–Douglas Production Function, 53 MATHEMATICS MAG. 44, 44–

45 (1980) (describing how the function is commonly featured in economics and even

calculus texts); Charles W. Cobb & Paul H. Douglas, A Theory of Production, 18 AM.

ECON. REV. (PAPERS & PROC.) 151–59 (Supp. 1928) (deriving and discussing the

formula); Paul H. Douglas, The Cobb–Douglas Production Function Once Again: Its

History, Its Testing, and Some New Empirical Values, 84 J. POL. ECON. 903, 903–04

(1976) (discussing the inputs of labor and capital within the Cobb–Douglas formula).

The now-familiar Cobb–Douglas formulation, Y = ALαKβ, with Y representing output,

L representing labor, and K representing capital, is a foundational relation in


2014] CAPITAL RIGIDITIES 721

as positively related to economic growth.2 If one asks (as

numerous economists have asked) the complicated question of

why some countries are so much richer and produce so much

more than others,3 one can easily rule out the availability of labor

as a limiting input because most developing countries are awash

in cheap labor.4 What is left? Capital.5 Furthermore, more capital

is always better. Additional capital may or may not be worth its

cost, but it never decreases productivity.6

Capital is good, except when it isn’t. After capital is

acquired, new information may emerge suggesting that the

economic theory. Beer, supra, at 44–45 (describing how output can be modeled by this

well-regarded function).

2. Robert Solow’s fundamental neoclassical growth model posits growth as a

general function of labor, capital, and technology, the latter being a multiplier that makes

the other two inputs more productive. Robert M. Solow, A Contribution to the Theory of

Economic Growth, 70 Q.J. ECON. 65, 66, 85 (1956); see also W. KIP VISCUSI, JOSEPH E.

HARRINGTON, JR. & JOHN M. VERNON, ECONOMICS OF REGULATION AND ANTITRUST 93 (4th

ed. 2005) (emphasizing Solow’s conclusion regarding the relative importance of technology

to output); George N. Hatsopoulos, Paul R. Krugman & Lawrence H. Summers, U.S.

Competitiveness: Beyond the Trade Deficit, 241 SCIENCE 299, 299, 301–02 (1988) (arguing

for a broader definition of capital to explain relative American lagging in productivity

growth); N. Gregory Mankiw, The Growth of Nations, BROOKINGS PAPERS ON ECON.

ACTIVITY, no. 1, 1995, at 275, 292, 308 (explaining the positive externalities to capital).

3. See, e.g., Douglas A. Hibbs, Jr. & Ola Olsson, Geography, Biogeography, and

Why Some Countries Are Rich and Others Are Poor, 101 PROC. NAT’L ACAD. SCI. 3715,

3715 (2004) (“The prosperity of nations varies enormously. . . . How can this large

variation in the wealth of nations be explained?”); Mathias Risse, What We Owe to the

Global Poor, 9 J. ETHICS 81, 83 (2005) (tracing the question back to Adam Smith’s Wealth

of Nations).

4. See, e.g., Michael P. Todaro, A Model of Labor Migration and Urban

Unemployment in Less Developed Countries, 59 AM. ECON. REV. 138, 138–39 (1969)

(“[E]ven the most casual observer of these countries cannot help but be overwhelmed by

the proportion of the urban labor force which is apparently untouched by the so-called

‘modern’ economy.”); Adrian Wood, Openness and Wage Inequality in Developing

Countries: The Latin American Challenge to East Asian Conventional Wisdom, 11 WORLD

BANK ECON. REV. 33, 34 (1997) (“The belief that increased openness reduces wage

inequality in developing countries rests on an apparently indisputable fact—that the

supply of unskilled labor, relative to the supply of skilled labor, is larger in developing

than in developed countries . . . .”).

5. Also, technology, which in the Cobb–Douglas and Solow formulations acts as a

multiplier for labor productivity and capital productivity, is not considered an input for

productivity. See, e.g., Paul Krugman, A Model of Innovation, Technology Transfer, and

the World Distribution of Income, 87 J. POL. ECON. 253, 254–55, 259 (1979) (developing a

model with labor as the only factor of production, while including technical progress only

in the form of the availability of new products, rather than an increased volume of

production of old products); Richard R. Nelson & Edmund S. Phelps, Investment in

Humans, Technological Diffusion, and Economic Growth, 56 AM. ECON. REV. (PAPERS &

PROC.) 69, 71 (1966) (“[T]echnical progress is Harrod-neutral everywhere (i.e., for all

capital-labor ratios), so that progress can be described as purely labor-augmenting.”).

6. Idiosyncratic exceptions may exist, but the Cobb–Douglas production function is

almost never deployed with capital having an inverse relationship with productivity. See

Beer, supra note 1, at 45 (describing the function as concave such that as long as there is

input, output will increase, even if at a decreasing rate).



capital might not be so useful after all.7 The new information

may reveal some harmful effects of operating that capital or

indicate that continued employment of that capital produces net

social harms. Or, the new information may suggest that capital is

outdated, and that other forms of capital or other technologies

would be more efficient and produce greater net social benefits.

In short, new information can render existing capital obsolete in

a number of different ways, most notably by revealing the

presence of latent negative externalities.8 But even obsolete

capital can be extremely difficult to dislodge.9 Unless obsolete

capital can be profitably redeployed, attempts to regulate or

internalize externalities10 resulting from the operation of capital

will be vigorously opposed by its owners.11

This theory of capital has special application to

environmental externalities, which are by their nature commonly

latent. The most serious environmental problems are no longer

obvious and visceral.12 Leaky industrial drums sitting atop

7. SHI-LING HSU, THE CASE FOR A CARBON TAX: GETTING PAST OUR HANG-UPS TO

EFFECTIVE CLIMATE POLICY 41, 43 (2011) (“[T]he problem with mandating an expensive

environmental technology is the economic irreversibility of capital expenditures.”);

Clayton Christensen, Thomas Craig & Stuart Hart, The Great Disruption, FOREIGN AFF.,

Mar./Apr. 2001, at 80, 81–82 (describing disruptive technologies—“cheaper, simpler, and

more convenient products or services”—and the challenges these technologies pose for

companies).

8. See Christensen, Craig & Hart, supra note 7, at 81–85 (discussing the effect of

“disruptive technologies”—a form of new information—on existing industries, noting that

these technologies “have plunged many of history’s best companies into crisis and,

ultimately, failure”).

9. See id. at 88–89 (contrasting the American economy’s success at repeating the

cycle of starting new companies that create disruptive growth disruption against the

Japanese economy’s failure to develop a venture-capital infrastructure); infra Part III.B

(explaining how the redeployment of capital is difficult due, in part, to switching costs).

10. An externality is a general term for an effect of a decision, on a party other than

the decision-maker, that the decision-maker does not take into account. For a discussion,

see Carl J. Dahlman, The Problem of Externality, 22 J.L. & ECON. 141, 147 (1979), which

discusses the transaction costs of externalities. “The conventional view of externalities,

whether associated with socially undesirable or desirable activities, is that externalities

arise as the unintended byproduct of otherwise self-serving activities.” Daniel B. Kelly,

Strategic Spillovers, 111 COLUM. L. REV. 1641, 1649–51 (2011).

11. See C. Edwin Baker, An Economic Critique of Free Trade in Media Products, 78

N.C. L. REV. 1357, 1418–19 (2000) (“For the firm, even if externalities reflect real

preferences that people theoretically are willing to pay to satisfy, as long as they are

externalities . . . these preferences are not brought to bear on the firm’s decisions, usually

because of transaction costs or collective action problems. Externalities are irrelevant

because they fall into neither the firm’s expense nor revenue column.”); infra Part III.B

(examining how overcapitalization creates resistance to policy reform).

12. See, e.g., JACK C. BENDER, THE DUTY TO DISCLOSE LATENT ENVIRONMENTAL

HAZARDS IN MINERAL PROPERTY TRANSACTIONS § 2.01 (1994), available at

http://www.emlf.org/clientuploads/directory/whitepaper/Bender_94.pdf (noting that many

environmental externalities of mineral extraction activities are “hidden and would not be

discovered or anticipated through visual inspection of the property”); Environmental



playgrounds are no longer the symbol of environmental blight.

The focus of environmental law has turned towards less visible

problems, such as the emission of carbon dioxide causing global

climate change,13 and the emission of fine particulate matter—

less than 2.5 microns in diameter—quietly causing millions of

premature deaths annually.14 But these kinds of environmental

problems only become apparent after decades of careful and

credible research.15 In the meantime, billions of dollars of capital

may accumulate without any serious attempt to consider the

possibility of latent externalities.

Reform or new legislation leading to resolution of modern

environmental problems has thus been elusive well before

Congress reached its current state of gridlock.16 Congress has not

passed a new federal environmental statute since 199017 despite

Effects of Acid Rain, EPA, http://www.epa.gov/region1/eco/acidrain/enveffects.html (last

updated Sept. 19, 2013) (discussing some of the more “subtle” effects of acid rain).

13. For a relatively brief treatment of this extremely broad, complex, and literature-

heavy problem, see generally ROBERT HENSON, THE ROUGH GUIDE TO CLIMATE CHANGE

(1st ed. 2006).

14. An extremely sophisticated body of epidemiological research has emerged over

decades of careful research linking concentrations of fine particulate matter with

premature mortalities. See, e.g., Francine Laden et al., Reduction in Fine Particulate Air

Pollution and Mortality: Extended Follow-up of the Harvard Six Cities Study, 173 AM. J.

RESPIRATORY & CRITICAL CARE MED. 667, 667–69 & tbl.1 (2006) (finding an increase in

overall mortality associated with each 10-µg/m3 increase in fine particulate matter

pollution); Johanna Lepeule et al., Chronic Exposure to Fine Particles and Mortality: An

Extended Follow-up of the Harvard Six Cities Study from 1974 to 2009, 120 ENVTL.

HEALTH PERSP. 965, 968 (2012) (finding evidence that exposure to fine particulate matter

can lead to early mortality); C. Arden Pope III et al., Lung Cancer, Cardiopulmonary

Mortality, and Long-term Exposure to Fine Particulate Air Pollution, 287 JAMA 1132,

1136 & tbl.2 (2002) (finding that exposure to fine particulate matter is associated with all-

cause, cardiopulmonary, and lung cancer mortality). Recent studies have estimated that

fine particulate matter pollution causes over two million premature deaths annually,

Raquel A. Silva et al., Global Premature Mortality Due to Anthropogenic Outdoor Air

Pollution and the Contribution of Past Climate Change, ENVTL. RES. LETTERS, July–Sept.

2013, at 1, 4, and 1.2 million deaths in China alone, Edward Wong, Early Deaths Linked

to China’s Air Pollution Totaled 1.2 Million in 2010, Data Shows, N.Y. TIMES, Apr. 2,

2013, at A9.

15. See, e.g., Lepeule et al., supra note 14, at 965, 968 (describing how research

regarding the health impact of fine particulate matter utilized data gathered by Harvard

from 1974 to 1977 and 1979 to 2009).

16. Jonathan H. Adler, Conservative Principles for Environmental Reform, 23 DUKE

ENVTL. L. & POL’Y F. 253, 253 (2013) (arguing that major reform is necessary because only

minor bills have passed since the Clean Air Act in 1990).

17. This Author considers the last significant federal environmental legislation

passed by Congress to be the Clean Air Act Amendments of 1990, Pub. L. No. 101-549,

104 Stat. 2399 (codified as amended at 42 U.S.C. §§ 7401–7671q (2006)). See also Barton

H. Thompson, Jr., A Federal Act to Promote Integrated Water Management: Is the CZMA a

Useful Model?, 42 ENVTL. L. 201, 203 & n.10 (2012) (“Congress has passed neither major

new environmental legislation nor significant water reform measures for almost two

decades.”).



the existence of a number of under-regulated industries.18

Prevailing explanations for this inertia in these areas of law fall

broadly into three categories: (i) public choice explanations;19

(ii) framing problems;20 and (iii) doubts about the importance of

the underlying problem.21 While all of these explanations have

18. Nicholas Z. Muller, Robert Mendelsohn & William Nordhaus, Environmental

Accounting for Pollution in the United States Economy, 101 AM. ECON. REV. 1649, 1665

(2011) (highlighting seven industries which are not efficiently regulated). Whether certain

industries and industrial practices are truly more harmful than productive is of course a

challenging question to answer, but an important recent analysis suggests good reason to

suspect there are many such industries. Id. at 1664–65. Using integrated assessment

models, which model environmental and economic impacts together, Muller, Mendelsohn,

and Nordhaus created an analysis of the net gross external damages of all point-source

polluters of all pollutants in the United States and found that their best estimates of

gross external damages of seven industries exceed their contribution to economic activity.

Id. at 1659, 1664–65. Those industries are solid waste combustion, stone mining and

quarrying, sewage treatment, oil- and coal-fired power generation, marinas, and

petroleum and coal products. Id. at 1665. Given the somewhat restrictive assumptions in

this study about, for example, nonmarket damages to ecological systems, one suspects

that there are many more than seven industries that are more harmful than valuable. Id.

at 1654, 1667, 1672–73.

19. For example, one common public choice explanation is that intensely affected

regulated industries are more motivated to resist reform than lightly affected and widely

dispersed majorities are to advance reform. See Gebhard Kirchgässner & Friedrich

Schneider, On the Political Economy of Environmental Policy, 115 PUB. CHOICE 369, 373,

377 (2003) (describing how industries burdened by environmental regulations are opposed

to the use of economic instruments). If that is the case, then one might expect the politics

of policy change to favor inertia. See JAMES M. BUCHANAN & GORDON TULLOCK, THE

CALCULUS OF CONSENT: LOGICAL FOUNDATIONS OF CONSTITUTIONAL DEMOCRACY 18, 21–

22, 29 (1962) (assuming actors will “choose ‘more’ rather than ‘less’ when confronted with

the opportunity for choice in a political process,” when “more” advances their economic

position); see also George J. Stigler, The Theory of Economic Regulation, 2 BELL J. ECON.

& MGMT. SCI. 3, 12 (1971) (discussing the high costs of legislative reform and stating that

“[t]he smallest industries are . . . effectively precluded from the political process”).

Another public choice explanation might be that agency actors and the industries they

regulate will have repeat interactions. IAN AYRES & JOHN BRAITHWAITE, RESPONSIVE

REGULATION: TRANSCENDING THE DEREGULATION DEBATE 54–55 (1992) (comparing this

repeat interaction to a multiperiod prisoner’s dilemma game). If that is the case, then one

would expect patterns of cooperation which might, in the face of policy change, give rise to

a systemic resistance to change, lest that upset a status quo that benefits both regulator

and regulated industry. See id. (discussing how the conditions that encourage cooperation

can also encourage capture and corruption).

20. For example, within the category of framing problems, one explanation could be

that the costs of environmental policy are more easily identified and visualized than the

environmental benefits, which tend to take on statistical forms. Shi-Ling Hsu, The

Identifiability Bias in Environmental Law, 35 FLA. ST. U. L. REV. 433, 440, 443–44 (2008)

(describing the statistical links between air pollution and health problems as “weak

attractors of sympathy”).

21. There are obviously conflicting accounts of whether the science of climate

change is sufficient or not, but most informed observers of the climate change debate

would agree that the risk of inaction is unjustifiable. A summary of the controversy can be

found in Shi-Ling Hsu, A Prediction Market for Climate Outcomes, 83 U. COLO. L. REV.

179, 181–89 (2011) (explaining how the distrustful general public has an “inflated

perception of the extent of disagreement among climate scientists”).



some explanatory power, a theory of how capital impedes energy

and environmental policy reform is the most broadly applicable.

This Article sets forth a theory that is more specific than most

public choice explanations and broader than most psychological

explanations. Just about every proposed reform to address a

latent environmental problem has emerged in the middle of the

economic life of some form of capital and posed a threat to some

individual, firm, or industry that had capital invested in the

status quo.22 Every proposed reform of significance creates losers;

this Article explains how they lose and how much they will resist

losing. If the continued exploitation of capital creates latent

externalities that were not appreciated (or were consciously

ignored) at its time of formation, a split in interests emerges:

cessation of use of the capital may be desirable from the social

point of view, but the owner of the capital will want to continue

to use the capital. This simple story is, in part, the story of

almost every latent externality ever created.

A particularly salient example of this dynamic revolves

around coal-fired electricity generation. Long-lived industrial

capital such as coal-fired power plants played an important role

in generating wealth throughout the world by providing low-cost

electricity.23 The low costs were made possible by abundant

supplies of coal that could be extracted at relatively low costs.24

Thousands of coal-fired power plants were built, and a vast

extraction and distribution network was created to mine coal and

deliver it to these power plants.25 Over time, however, a great

deal of information has emerged suggesting that although the

private costs of mining and burning coal are low, these direct

costs are swamped by the social and environmental costs of coal

mining and combustion.26 Also, new technologies and new

22. See infra note 100 and accompanying text (explaining that reform will only take

place when capital assets have “remaining life”).

23. For a general history of coal, see generally BARBARA FREESE, COAL: A HUMAN

HISTORY (2003).

24. Id. at 6–7; Sean Patrick Adams, The US Coal Industry in the Nineteenth

Century, ECON. HISTORY ASS’N, http://www.eh.net/encyclopedia/the-us-coal-industry-in-

the-nineteenth-century-2/ (last visited Feb. 6, 2014) (describing coal in the nineteenth

century as “cheap and efficient” and detailing the innovations in coal mining that

facilitated extraction).

25. FREESE, supra note 23, at 118–26.

26. Epidemiological work undertaken over decades has shown that by far, the

greatest cost of coal combustion is in the human toll of premature deaths occurring due to

fine particulate matter emissions. See supra note 14 and accompanying text (discussing

research linking concentrations of fine particulate matter to premature mortalities). For

an estimate of the total damages from coal combustion, see Roberta Mann, Another Day

Older and Deeper in Debt: How Tax Incentives Encourage Burning Coal and the

Consequences for Global Warming, 20 PAC. MCGEORGE GLOBAL BUS. & DEV. L.J. 111,



sources of energy (most prominently natural gas) have emerged

suggesting that coal is not even the cheapest fossil fuel for

generating electricity.27 But the sprawling network of coal

production, distribution, and combustion is fixed. It cannot be

easily redeployed in a low-carbon economy.28 This capital rigidity

has created a huge number of parties with a tremendous stake in

its continued existence.29

This Article sets out a theory of capital that explains how

legal rules and institutions create resistance to reform, especially

attempts to address environmental externalities. Part II of this

Article sets out a working definition of the term “capital.” This

Part also briefly describes the three different types of capital

considered in this Article: physical, human, and social capital.

Part III of this Article sets out examples of how capital impedes

reform attempting to address latent externalities. Part IV

118–25 (2007) (listing external costs on society resulting from the use of coal, including

worker accidents, acid precipitation, and loss of topsoil); Muller, Mendelsohn & Nordhaus,

supra note 18, at 1661, 1665 tbl.2 (discussing the Laden et al. study and showing, using

integrated assessment economic models, external damages of $53.4 billion, which is 2.2

times greater than the value added by coal-fired electricity generation).

27. See Electricity from Non-Hydroelectric Renewable Energy Sources, U.S. ENVTL.

PROT. AGENCY, http://www.epa.gov/cleanenergy/energy-and-you/affect/non-hydro.html

(last updated Sept. 25, 2013) (describing how biomass is better for the environment than

burning coal). Natural gas has long been known to be less polluting than coal and, at least

in the environmental sense, a superior fossil fuel. See Electricity from Natural Gas, U.S.

ENVTL. PROT. AGENCY, http://www.epa.gov/cleanenergy/energy-and-you/affect/natural-

gas.html (last updated Sept. 25, 2013). More recently, the emergence of hydraulic

fracturing technology has rendered natural gas inexpensive enough to rival coal as the

fuel of choice for electricity generating firms. See, e.g., Electric Power Monthly, U.S.

ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY (Sept. 20, 2013),

http://www.eia.gov/electricity/monthly/epm_table_grapher.cfm?t=epmt_1_01 (showing net

generation from natural gas approaching that of coal); Ken Silverstein, Obama Trying to

Escape Political Fallout from Natural Gas Fracking Proposals, FORBES (Sept. 6, 2013),

http://www.forbes.com/sites/kensilverstein/2013/09/06/obama-trying-to-escape-political-

fallout-from-natural-gas-fracking-proposals/ (describing how the Obama administration

discourages coal-fired power plants and encourages natural gas, which is easier to access

due to hydraulic fracturing, or “fracking”).

28. Coal-fired power plants can be converted to natural-gas-fired power plants, but

the conversion is usually too costly and burdensome. See, e.g., ERIC WILLIAMS ET AL.,

CLIMATE CHANGE POLICY P’SHIP, DUKE UNIV., A CONVENIENT GUIDE TO CLIMATE CHANGE

POLICY AND TECHNOLOGY 37, 39–40 (2007), available at http://www.nicholas.duke.edu/

ccpp/convenientguide/PDFs/ClimateBook.pdf (giving examples of coal-fired power plants

that have been “repowered,” but conceding that “retiring all coal-fired power plants and

replacing them with less carbon-intensive plants is not economically or politically

feasible”); Daniel Cusick, Study: Switch From Coal to Gas Poses Some Risks for Utilities,

MIDWEST ENERGY NEWS (Sept. 12, 2013), http://www.midwestenergynews.com/2013/09/

12/study-converting-coal-to-gas-poses-some-risks-for-utilities/ (describing how

investments in conversion of a plant are risky due to the uncertain future of the energy

market, particularly the impact of regulations).

29. See infra Part IV.B (discussing how further capital formation in the mining

industry would thwart much-needed policy reform).



explains how current laws and governmental structures either

overpromote the formation of capital or overprotect it once it is

formed or acquired. Part V argues for a refocusing of government

subsidies on true public goods. Specifically, this Part argues that

government policy should focus more on network goods, and not

just on capital projects that lower commodity prices. This Article

then concludes with some general observations on laws affecting

the formation and protection of capital.

II. WHAT IS CAPITAL?

The term “capital” has an almost universally positive

connotation.30 A fair amount of government policy seems to be

oriented toward promoting the formation and acquisition of

capital. Scattered liberally throughout the Internal Revenue

Code are generous provisions to assist with the formation and

acquisition of capital,31 especially for small businesses.32

President Obama’s economic stimulus packages of 2008 and 2009

included temporary provisions to allow an increased tax

deduction for certain capital equipment.33 There is even a

Washington-based advocacy group that extols the virtues of

30. The Future of Capital Formation: Hearing Before the Comm. on Oversight &

Gov’t Reform, 112th Cong. 4 (2011) (statement of Mary Schapiro, Chairman, U.S.

Securities and Exchange Commission), available at http://www.gpo.gov/fdsys/pkg/CHRG-

112hhrg70517/pdf/CHRG-112hhrg70517.pdf (“Facilitating capital formation, protecting

investors, and maintaining fair, orderly, and efficient markets is the mission of the SEC.

Cost-effective access to capital for companies of all sizes plays a critical role in our

national economy, and companies seeking access to capital should not be overburdened by

unnecessary or superfluous regulations.”). Also, Section 2 of the Securities Act of 1933

regarding “consideration of promotion of efficiency, competition, and capital formation”

provides, in part:

Whenever pursuant to this subchapter the Commission is engaged in

rulemaking and is required to consider or determine whether an action is

necessary or appropriate in the public interest, the Commission shall also

consider, in addition to the protection of investors, whether the action will

promote efficiency, competition, and capital formation.

15 U.S.C. § 77b(b) (2012).

31. See, e.g., Robert E. Hall & Dale W. Jorgenson, Tax Policy and Investment

Behavior, 57 AM. ECON. REV. 391, 391, 410 (1967) (attributing investment booms in the

1950s and 1960s to changes in tax policy).

32. See, e.g., Douglas Holtz-Eakin, Public Policy Toward Entrepreneurship, 15

SMALL BUS. ECON. 283, 288–89 (2000) (describing such benefits for small businesses

including, for example, possible yearly deductions of up to $17,500 in capital

expenditures); Philip F. Zeidman et al., The Small Business Investment Company—A Tool

for Economic Self-Help, 21 BUS. LAW. 947, 950, 961 (1966) (describing the special tax

benefits for small business investment companies, such as creating a debt reserve of up to

ten percent of outstanding loans and special rules for the deduction of dividends).

33. Economic Stimulus Act of 2008, Pub. L. No. 110-185, § 103, 122 Stat. 613, 618–

19; American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5, § 1201, 123 Stat.

115, 333–35.



capital formation for its own sake, the American Council for

Capital Formation.34 The worship of capital may be even more

pronounced in capital-poor developing countries, for which

prescriptions center upon making capital more available.35 It is

the formation of capital, everyone seems to believe, that creates

low commodity prices and broadly distributed benefits,

unleashing the industry and entrepreneurship of individuals and

firms in an economic society.

And yet, despite our universal admiration for capital, a

precise and widely accepted definition of capital is elusive. Adam

Smith defined it as “[h]is . . . stock . . . . which, he expects, is to

afford him [his] revenue.”36 In a similar vein, Robert Solow has

defined it in passing as generically a “stock of produced or

natural factors of production that can be expected to yield

productive services for some time.”37 Gregory Mankiw posits

capital as current consumption forgone to produce more income

tomorrow.38 Undergraduate textbooks simply model production

as a function of just two types of inputs: capital and labor.39 This

dichotomy is a gross oversimplification, of course. Labor is

required to build the capital in the first place; in that sense,

capital can simply be thought of as stored labor.40

34. Economic Policy, AM. COUNCIL FOR CAPITAL FORMATION, http://accf.org/

publications/#economic-policy-tab (last visited Feb. 6, 2014).

35. Hernando de Soto’s The Mystery of Capital propounds a theory that people in

developing countries fail to accumulate wealth because their property cannot be leveraged

as capital the way that it can in developing countries. HERNANDO DE SOTO, THE MYSTERY

OF CAPITAL: WHY CAPITALISM TRIUMPHS IN THE WEST AND FAILS EVERYWHERE ELSE 5–6

(2000). Muhammad Yunus won a Nobel Peace Prize for his pioneering work in the

business of microfinance in poor communities, making small loans to collateral-poor

entrepreneurs. Muhammad Yunus—Facts, NOBEL PRIZE, http://www.nobelprize.org/

nobel_prizes/peace/laureates/2006/yunus-facts.html (last visited Jan. 18, 2014).

36. ADAM SMITH, AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF

NATIONS 162 (Kathryn Sutherland ed., Oxford Univ. Press 1998) (1776).

37. Robert M. Solow, Notes on Social Capital and Economic Performance, in SOCIAL

CAPITAL: A MULTIFACETED PERSPECTIVE 6 (Partha Dasgupta & Ismail Serageldin eds.,

2000).

38. Mankiw, supra note 2, at 293.

39. David Gordon & Richard Vaughan, The Historical Role of the Production

Function in Economics and Business, AM. J. BUS. EDUC., Apr. 2011, at 25, 25. The now-

familiar Cobb–Douglas formulation, Y = ALαKβ, is a relation which every economics

student learns about in undergraduate economics, and it posits production as a function

of the quantity and productivity of just two types of inputs: labor (L) and capital (K). See

generally Cobb & Douglas, supra note 1 (deriving and discussing the Cobb–Douglas

formula); Douglas, supra note 1 (discussing the inputs of labor and capital within the

Cobb–Douglas formula). Robert Solow’s fundamental neoclassical growth model posits

growth as a general function of labor, capital, and technology, the latter being a multiplier

that makes the other two inputs more productive. Solow, supra note 2, at 65–66, 85.

40. Hernando de Soto notes that capital “must be fixed and realized in some

particular subject which lasts for some time at least after that labour is past. It is, as it



These, and a number of other definitional complexities, have

led to some more conceptual and less rigid formulations of

capital. Gary Becker has, in his seminal work, married labor and

capital into “human capital” to denote the amount of human

training and education that is undertaken to produce other

things (or services).41 Indeed, a broad notion of capital is central

to the thesis of this Article, as the mystery of how capital retards

environmental policy reform can only be unlocked when

considering the many forms of capital invested in polluting

behavior.

This Article sets forth a working definition that does not

seek to bridge or synthesize differences among the economic

giants that have considered this topic. For purposes of this

Article, I define capital as a long-lived asset that generates a

stream of benefits. Capital is long-lived in the sense that it is

meant to be durable and undergo sustained use over a period of

time or more generally over a quantity of production.42 Capital

generates a stream of benefits because that is why it is obtained

in the first place.43

Capital is not necessarily costly. In some cases, capital is

accumulated without effort or cost.44 But even in such cases of

windfall capital, a possessor’s defense of that capital can be as

vigorous as that of costly capital.45 The costliness of capital may,

were, a certain quantity of labour stocked up and stored to be employed, if necessary,

upon some other occasion.” DE SOTO, supra note 35, at 42 (internal quotation marks

omitted).

41. GARY S. BECKER, HUMAN CAPITAL: A THEORETICAL AND EMPIRICAL ANALYSIS,

WITH SPECIAL REFERENCE TO EDUCATION 16–17 (3d ed. 1993) (expounding on the concept

of “human capital” and claiming that “[e]ducation and training are the most important

investments in human capital”).

42. See Paul S. Adler & Seok-Woo Kwon, Social Capital: Prospects for a New

Concept, 27 ACAD. MGMT. REV. 17, 25 (2002) (defining all forms of capital as “long-lived

asset[s] into which other resources can be invested, with the expectation of a

future . . . flow of benefits”); Solow, supra note 37, at 6 (“Generically, ‘capital’ stands for a

stock of produced or natural factors of production that can be expected to yield productive

services for some time.”).

43. See, e.g., Franco Modigliani & Merton H. Miller, The Cost of Capital,

Corporation Finance, and the Theory of Investment, 48 AM. ECON. REV. 261, 265 (1958)

(stating that a firm’s assets will provide its shareholders with a “stream of profits” during

a given period of time (internal quotation marks omitted)).

44. See, e.g., BECKER, supra note 41, at 21–22 (illustrating how human capital can

be accumulated and developed through children’s family and upbringing); Elinor Ostrom,

Social Capital: A Fad or a Fundamental Concept?, in SOCIAL CAPITAL: A MULTIFACETED

PERSPECTIVE, supra note 37, at 172, 174 (“Many types of capital can be created without

money, or with very little of it . . . .”).

45. See, e.g., Christopher L. Dyer & Mark Moberg, The ‘Moral Economy’ of

Resistance: Turtle Excluder Devices and Gulf of Mexico Shrimp Fishermen, 5 MAR.

ANTHROPOLOGICAL STUD., no. 1, 1992, at 18, 20–21 (explaining how fishermen develop

their skill sets and “vehemently resist perceived threats to livelihood”).



for psychological reasons, inspire more spirited defense, but for

purposes of this Article is not a predicate to the points made in

this Article.

I consider three kinds of capital: physical, human, and

social.46 There are many other kinds of assets to which the label

of “capital” has been attached.47 But these three forms of capital,

as I describe them below, are the forms of capital that have

played a prominent role in retarding policy reform to address

latent environmental externalities.48

Physical capital is capital that takes on a tangible, physical

form.49 For example, a power plant, with a useful life of at least

forty years,50 is an asset that generates a stable stream of

revenues in the form of consumer electricity payments. Indeed,

ensuring that environmental regulation does not threaten the

size or the continuity of that stream of benefits occupies a

considerable amount of attention from the owners of that

capital.51 A stable regulatory and price environment is the ideal

46. Many scholars consider social capital to be a recent addition to the three

previously widely-accepted forms of capital: physical, human, and natural. See Ostrom,

supra note 44, at 172–76; Norman Uphoff, Understanding Social Capital: Learning from

the Analysis and Experience of Participation, in SOCIAL CAPITAL: A MULTIFACETED

PERSPECTIVE, supra note 37, at 215, 215, 217 (noting that social capital is a recent

conceptualization of capital, which traditionally has consisted of “the standard three

categories of capital”—physical, natural, and human).

47. Natural resources and environmental conditions can constitute “natural

capital.” See, e.g., Ostrom, supra note 44, at 174, 182 (inferring that natural resources are

a form of capital because the removal of natural resources can be detrimental to social

capital); M.V. Russo, The Emergence of Sustainable Industries: Building on Natural

Capital, 24 STRATEGIC MGMT. J. 317, 320 (2003) (defining “natural capital” in terms of

natural resources). Capital can also be financial. The term “capital markets” is commonly

used to refer to equity markets, or stock markets, in which invested monies are hoped to

generate a future benefit in the form of a stock dividend or an increased share value over

time. See Eugene F. Fama, Efficient Capital Markets: A Review of Theory and Empirical

Work, 25 J. FIN. 383, 383 (1970) (“The primary role of the capital market is allocation of

ownership of the economy’s capital stock.”); Lindon J. Robison, A. Allan Schmid &

Marcelo E. Siles, Is Social Capital Really Capital?, 60 REV. SOC. ECON. 1, 7 (2002)

(defining financial capital as “the symbols and rights associated with credit and money”).

48. See discussion infra Part III.A–B. (describing how capital has encumbered

policy reform in certain industries, which, in turn, has led to environmental problems).

49. See Ostrom, supra note 44, at 174 (providing examples of “physical capital” such

as “buildings, roads, waterworks, tools, cattle and other animals, automobiles, trucks, and

tractors”).

50. For example, a recent regulation by Environment Canada to apply a new

emissions performance standard for coal-fired power plants “at the end of their useful life”

assumed a useful life of a power plant to be forty-five years. Reduction of Carbon Dioxide

Emissions from Coal-Fired Generation of Electricity Regulations, 145 C. Gaz. 2779, 2783

(Can. Aug. 27, 2011), available at http://www.gazette.gc.ca/rp-pr/p1/2011/2011-08-

27/pdf/g1-14535.pdf.

51. See, e.g., Satish Joshi, Ranjani Krishnan & Lester Lave, Estimating the

Hidden Costs of Environmental Regulation, 76 ACCT. REV. 171, 173–74, 194 (2001)

(providing an example of how industries consider the stream of benefits and costs



environment, if not the sine qua non of the investment of such

capital.52 The costliness of physical capital such as a power

plant,53 coupled with the long time horizons involved in paying

for such capital,54 lends urgency to the task of monitoring and

managing, to the greatest extent possible, the regulatory and

price environments.

Human capital is most often thought of as education and

training.55 Generally speaking, the higher the education, the

greater the value of the human capital.56 Education can be costly,

not only because of direct costs, but also because of the

when determining whether to bring old plants into environmental compliance or to

shut them down).

52. See Alfred Marcus, J. Alberto Aragon-Correa & Jonatan Pinkse, Firms,

Regulatory Uncertainty, and the Natural Environmental, 54 CAL. MGMT. REV. 5, 8–9

(2011) (observing that when the “regulatory trajectory” is certain, industries and firms

will have more stability in their investments).

53. Coal-fired power plants that entered service in 2010 have an estimated average

“overnight” capital cost of $2,844 to $3,565 per kilowatt of capacity. See U.S. ENERGY

INFO. ADMIN., U.S. DEP’T OF ENERGY, UPDATED CAPITAL COST ESTIMATES FOR

ELECTRICITY GENERATION PLANTS 3, 7 tbl.1 (Nov. 2010), available at http://www.eia.gov/

oiaf/beck_plantcosts/pdf/updatedplantcosts.pdf. The overnight capital cost is “an estimate

of the cost at which a plant could be constructed assuming that the entire process from

planning through completion could be accomplished in a single day.” Id. at 2 n.2.

54. As a crude order-of-magnitude calculation, assuming a capacity rate of eighty-

five percent—meaning that the plant runs at an average long-term capacity of eighty-five

percent, an assumption made by the U.S. Department of Energy in calculating capital

costs—a 500-megawatt power plant would generate 425 megawatt-hours every hour,

every day, or 3,723,000 megawatt-hours per year. U.S. ENERGY INFO. ADMIN., U.S. DEP’T

OF ENERGY, LEVELIZED COST OF NEW GENERATION RESOURCES IN THE ANNUAL ENERGY

OUTLOOK 2013, at 4 & tbl.1 (2013), available at http://www.eia.gov/forecasts/aeo/er/pdf/

electricity_generation.pdf. Using the average 2011 nationwide retail price of electricity,

$88.10 per megawatt-hour, U.S. ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY, ANNUAL

ENERGY REVIEW 2011, at 255 & tbl.8.10 (2012), available at http://www.eia.gov/

totalenergy/data/annual/pdf/sec8_39.pdf, and subtracting out average operations and

maintenance costs of $35.09 per megawatt-hour, U.S. ENERGY INFO. ADMIN., U.S. DEP’T

OF ENERGY, ELECTRIC POWER ANNUAL 2011, tbl.8.4 (2012), available at

http://www.eia.gov/electricity/annual/pdf/epa.pdf, it would take 7.8 years to pay back the

capital costs. Of course, this crude calculation omits many other costs, factors, and

variables, including finance costs, transmission costs, and other expenses associated with

running a power plant.

55. BECKER, supra note 41, at 17.

56. See id. at 169–70 & tbl.4, 223–24 & tbl.17 (showing greater earning capacities

for college graduates compared to high school graduates). Although the marginal returns

to a college education have not always been historically higher than the marginal returns

to high school education, the marginal returns to college education have always been

positive. See CLAUDIA GOLDIN & LAWRENCE F. KATZ, THE RACE BETWEEN EDUCATION AND

TECHNOLOGY 76, 78–79 & tbl.2.5 (2008) (showing positive returns to college schooling);

Richard Vedder, Universities and Income Equality: New Evidence and Conjectures,

CHRON. HIGHER EDUC. (Aug. 25, 2011), http://www.chronicle.com/blogs/innovations/

universities-and-income-equality-new-evidence-and-conjectures (discussing the “law of

diminishing returns” as applied to higher education).



opportunity costs of forgone income.57 Indisputably, human

capital is valuable, as productivity is observed to be clearly and

consistently greater in the presence of human capital.58 Thus

human capital is, by itself, something that generates a stream of

benefits, in the form of earnings that would not otherwise be

realized.

Importantly, human capital need not be formal. While

human capital is most easily conceived as formal schooling or on-

the-job training,59 there are clearly many other forms of human

capital. Human capital may be the acquired knowledge of some

facet of resource extraction, or some operational expertise

connected to a specific industrial process. The acquisition of

human capital may not be part of any organized effort at all.

Microsoft co-founder Bill Gates and Apple co-founder Steve Jobs,

both college dropouts, owe a considerable amount of their success

to human capital they acquired at early, formative stages of life.60

In almost all cases, human capital requires significant costs to

obtain, has the potential to be long-lived, and can generate a

long-lived stream of benefits.61

Finally, social capital, as it is conceived in this Article,

consists of the variety of interpersonal and intra-organizational

bonds that are formed when one signals to another that

cooperation is sought.62 Among economists, there is some

57. See, e.g., Theodore W. Schultz, Capital Formation by Education, 68 J. POL.

ECON. 571, 573, 577 (1960) (stating that students incur opportunity costs while in college

such as reduced leisure and forgone income from employment not requiring an education).

58. Theodore W. Schultz, Investment in Human Capital, 51 AM. ECON. REV. 1, 3

(1961) (“[K]nowledge and skill are in great part the product of investment and, combined

with other human investment, predominantly account for the productive superiority of

the technically advanced countries.”).

59. For example, Becker’s original empirical work focuses on the measurable

benefits of schooling and on-the-job training. See BECKER, supra note 41, at 17–21 (noting

that the most important components of human capital are education and on-the-job

training).

60. MALCOLM GLADWELL, OUTLIERS: THE STORY OF SUCCESS 50–54 (2008)

(describing the “extraordinary series of opportunities” that Gates was presented with at

an early age); WALTER ISAACSON, STEVE JOBS 3–20 (2011) (illustrating how Steve Jobs

acquired human capital at an early age by getting hands-on experience with computers

and electronics).

61. See BECKER, supra note 41, at 117 (stating that human capital is expensive due

to the high cost of education and the long period required to accumulate knowledge and

skills); James S. Coleman, Social Capital in the Creation of Human Capital, 94 AM. J.

SOC. 95, 116 (Supp. 1988) (“[T]he person who invests the time and resources in building

up [human] capital reaps its benefits in the form of a higher-paying job, more satisfying or

higher-status work, or even the pleasure of greater understanding of the surrounding

world.”).

62. See Ostrom, supra note 44, at 176 (defining “social capital” and noting that

individuals can be more productive when activities are coordinated).



controversy as to whether the term “capital” can be coherently

applied to something like the social interactions that make up

what is popularly referred to as social capital.63 For those

economists that engage with the concept of social capital, the

focus is typically on how it increases productivity. After all, what

good would social capital be, apart from the psychological

benefits of social belonging?64 If social capital is to have economic

content, then it must have a role in economic performance.

What is different about social capital is that the social

interactions that make up social capital do not primarily have

economic motivations. The concept of social capital thus draws

heavily from the work of Robert Putnam’s Bowling Alone,65

which chronicles the decline of social institutions in the United

States, the result of which is a lack of a social fabric that made

many cooperative endeavors possible in the past.66 Putnam’s

argument is that social networks enhance political and civic

life without consciously having these outcomes as objectives.67

The economic perspective is thus analogous to Putnam’s

argument: social capital enhances economic productivity

without consciously having economic productivity as its

primary goal.68

63. See, e.g., Kenneth J. Arrow, Observations on Social Capital, in SOCIAL CAPITAL:

A MULTIFACETED PERSPECTIVE, supra note 37, at 3, 3–4 (advocating the abandonment of

“social capital” terminology); Robison, Schmid & Siles, supra note 47, at 7–8 (“We don’t

need the new word ‘social capital.’”); Solow, supra note 37, at 6–7 (criticizing the idea of

“social capital” because the original meaning of “capital” was associated with physical,

durable objects).

64. Economists argue that joining social networks have noneconomic benefits, and

are at least in part the motivation for joining. See, e.g., Arrow, supra note 63, at 3 (“There

is considerable consensus also that much of the reward for social interactions is

intrinsic—that is, the interaction is the reward—or at least that the motives for

interaction are not economic. People may get jobs through networks of friendship or

acquaintance, but they do not, in many cases, join the networks for that purpose.”);

Robison, Schmid & Siles, supra note 47, at 7–17 (explaining how some critics argue that

social capital does not contain an opportunity cost, which is an essential component to

true “capital,” but arguing that social capital does in fact exhibit many of the qualities of

“capital”).

65. See ROBERT D. PUTNAM, BOWLING ALONE: THE COLLAPSE AND REVIVAL OF

AMERICAN COMMUNITY 351–52, 358 (2000) (discussing how social capital is intertwined

with the concepts of liberty, tolerance, and equality).

66. Id. at 352–59 (positing that social capital began to decline in the 1960s when

“tolerance and diversity blossomed,” causing Americans to become “disconnected from

civic life and from one another”).

67. Id. at 359 (“[I]n high-social-capital states people from different social classes are

equally likely to attend public meetings, to lead local organizations, and the like . . . .”).

68. See Arrow, supra note 63, at 4 (“The essence of social networks is that they are

built up for reasons other than their economic value to the participants . . . .”); Ostrom,

supra note 44, at 174 (observing that human-made capital, including social capital, is

accumulated incidental to other activities and leads to more income).



Drawing on the working definition of capital set forth in this

Article, social capital is just another asset that is long-lived and

can generate a long-lived stream of benefits. Of the three forms of

capital considered in this paper, it is the least costly and time-

consuming to acquire, and the stream of benefits flowing from it

consists of a number of intangible benefits, be it informational

benefits or just the small favors and graces extended to those

within a social fabric.69 These benefits can be extremely

important. James Coleman provides a compelling example of the

importance of social capital in the Jewish diamond merchant

community, in which merchants entrust fellow merchants with

diamonds worth very large amounts of money.70 The reason that

thievery is nonexistent in this community, despite ample

opportunity to engage in it, is explained by the social

interconnectedness of the merchants. Stealing would result in

ostracism from a community and forfeiture of social, family, and

religious ties.71 Social capital thus often plays a vital economic

role, lubricating mercantile relations while obviating the need for

expensive and perhaps ultimately futile monitoring.72

Social capital could play a critical role in motivating poor,

resource-based communities to fight regulation. In resource-

based communities otherwise lacking in physical or human

capital, social capital is a more egalitarian form of capital,

requiring few of the financial resources that are necessary and

sometimes unavailable to socioeconomically disadvantaged

groups.73 Strong social interconnectedness has been observed in a

variety of fishing communities.74 As it happens, fishers are, even

among resource industries, legendary for their resistance to

regulation.75 As in the Jewish diamond broker example, trust and

69. See, e.g., Coleman, supra note 61, at 98–99 (inferring that social capital requires

fewer expenditures because it is formed through relations and interactions).

70. Id.

71. Id. at 99.

72. See id. (observing that strong “family, religious, and community ties” yield

relationships built on trust with little cost).

73. Putnam has written that “[h]istorically social capital has been the main weapon

of the have-nots, who lacked other forms of capital.” PUTNAM, supra note 65, at 359.

74. James M. Acheson, The Maine Lobster Market: Between Market and Hierarchy,

1 J.L. ECON. & ORG. 385, 385–86 (1985); Sean R. Lauer, Entrepreneurial Processes in an

Emergent Resource Industry: Community Embeddedness in Maine’s Sea Urchin Industry,

70 RURAL SOC. 145, 156, 158–59, 162 (2005); James A. Wilson, Adaptation to Uncertainty

and Small Numbers Exchange: The New England Fresh Fish Market, 11 BELL J. ECON.

491, 494–95 (1980).

75. See, e.g., Dyer & Moberg, supra note 45, at 27–31 (examining the strong

resistance among shrimp fishermen toward federal regulation); Shi-Ling Hsu, What Is a

Tragedy of the Commons? Overfishing and the Campaign Spending Problem, 69 ALB. L.

REV. 75, 128 (2005); Barton H. Thompson, Jr., Tragically Difficult: The Obstacles to



reciprocity, the social capital that is formed from long-running

relationships, have served a vital economic purpose for low-profit

industries that cannot afford expensive or time-consuming

monitoring efforts.76 Indeed, when social capital is low—when

interconnectedness is not present—fishing communities that

otherwise resemble other communities with high social capital

function much less efficiently and are much less profitable.77

Social capital is still, in a sense, costly to obtain, as it

requires time and effort to earn trust and to credibly signal the

intent to cooperate. Like physical and human capital, once

created by sustained cooperation or assistance, social capital can

yield a stream of benefits that becomes extremely valuable and in

some cases, economically necessary. Even though social capital is

not readily monetizable, it can be even more valuable to its

holder than tangible assets like physical capital.78 Perhaps more

significantly, it can be the only form of capital held by some

individuals and some groups.79

To be sure, most capital contains combinations of all three

kinds of capital.80 Physical capital contains the embedded human

capital required to design and build a highly sophisticated and

expensive piece of equipment. Social capital is invariably

embedded as well, in the form of the informal cooperative

arrangements that are needed for a large-scale endeavor to be

productive. Physicality is just the most obvious aspect of capital.

III. HOW CAPITAL IMPEDES REFORM

Exactly how does the presence of excess capital impede

policy reform? This Part briefly describes the capital that is

Governing the Commons, 30 ENVTL. L. 241, 244–45 (2000) (“Many resource users,

moreover, might conclude that they are better off in a commons free-for-all than in a

world constrained by property rights, unified management, or regulation.”).

76. Coleman, supra note 61, at 98–99; Wilson, supra note 74, at 495 (“[T]he

economic significance of a trustworthy relationship lies in the reduction in [an

individual’s] costs of verifying the statements of the other party. This reduction in

transactions costs creates strong economic forces which favor the extension of the

bilateral relationship to exchanges of other goods and services.”).

77. See Sean R. Lauer, Exchange Relationships in Inshore Fisheries, 23 SOC. F. 503,

506–07 (2008) (discussing how low social capital creates distrust and opportunism,

causing increased transaction costs due to “frequent misunderstandings, conflicts, delays

and breakdowns, and increased investment in the monitoring of exchanges”).

78. Adler & Kwon, supra note 42, at 22, 29–30; see PUTNAM, supra note 65, at 359

(showing that groups of individuals lacking the means to obtain expensive forms of capital

rely heavily on social capital).

79. PUTNAM, supra note 65, at 359.

80. Coleman, supra note 61, at 100–01 (describing the linkage between physical,

human, and social capital).



embedded in a number of industries that have been belatedly

shown to cause a number of environmental problems. This Part

then sets out a simple model showing how relatively small

incentives for capital formation might lead to large increases in

capital investment, creating a tendency to “super-size” capital.

A. Overcapitalization as a Drag on Environmental Reform

The thesis of this Article is that legal rules and institutions

have helped create too much capital, which has led to a

heightened resistance to legal reform. Legal rules and

institutions have overpromoted the formation of capital that is

later discovered to cause latent environmental harms.81 Even

after the latent environmental harms come to light, laws have

overprotected capital at the expense of environmental quality.82

This is at least in part the story of how almost every

environmental externality has been allowed to persist longer

than a rational society would have allowed.83 In some way,

capital has gotten in the way of solving almost every

environmental problem in the history of humankind.84

It is important to consider capital in its varied forms, not

just the physical capital—the bricks and mortar that are easily

priced and monetizable—but the human and social capital that is

intertwined with industrial practices and processes. The

81. See, e.g., Shi-Ling Hsu, The Real Problem with New Source Review, 36 ENVTL. L.

REP. 10,095, 10,096–98 (2006) (discussing “grandfather clauses” and how such laws have

permitted industries to infuse more capital into older facilities, leading to environmental

problems); Heidi Gorovitz Robertson, If Your Grandfather Could Pollute, So Can You:

Environmental “Grandfather Clauses” and Their Role in Environmental Inequity, 45

CATH. U. L. REV. 131, 168–70 (1995) (suggesting that “grandfather clauses” have allowed

industries to opt out of complying with environmental regulations, thus avoiding

expensive capital outlays and causing further environmental damage).

82. See, e.g., Robertson, supra note 81, at 168–70 (asserting that laws such as

“grandfather clauses” have overprotected capital at the expense of environmental harm).

83. Id. (advocating that the allowance of capital-protective laws prolongs

environmental harms).

84. See, e.g., Cees van Beers & Jeroen C.J.M. van den Bergh, Environmental Harm

of Hidden Subsidies: Global Warming and Acidification, 38 AMBIO 339, 339–41 (2009)

(explaining how reliance on government subsidies, a form of capital, have prolonged

environmental emissions problems); R.T. Paine et al., Trouble on Oiled Waters: Lessons

from the Exxon Valdez Oil Spill, 27 ANN. REV. ECOLOGY & SYSTEMATICS 197, 222, 228

(1996) (discussing how then-existing capital was ineffective to clean up the Exxon Valdez

oil spill and suggesting superior capital); Lawrence C. Smith, Jr., L. Murphy Smith &

Paul A. Ashcroft, Analysis of Environmental and Economic Damages from British

Petroleum’s Deepwater Horizon Oil Spill, 74 ALB. L. REV. 563, 565, 572–74 (2010)

(attributing lack of physical and human capital, such as clean-up crews, vessels, and

equipment, to the Deepwater Horizon oil spill’s damaging effects, as well as lack of social

capital in the form of blocking aid from countries that had offered to help with the

cleanup).



operation of physical capital to generate wealth requires a

tremendous amount of human capital and industry-specific

know-how. In addition, any endeavor of any reasonable size

requires informal cooperation and the development of a network

of social capital. The importance of such human and social capital

is likely to be understated because their acquisition costs will

generally not reflect their intrinsic value.85 For individuals

possessing human capital that would be devalued by changes in

industrial practices (such as oil rig or oilfield workers), or social

capital that is specific to a small town that is predicated on a

specific practice (such as that of a fishing or coal-mining

community), their role in an anachronistic industry may be the

only realistic source of income or sustenance. If, as is very often

the case, these kinds of human or social capital may not be

transferred to another setting, the switching costs for these

people are essentially infinite. Were the source of income in these

industries and communities to dry up, these people would

essentially lose everything. That desperation may be a false

perception, but for purposes of explaining the level of resistance

to reform, it may as well be reality.

When these broader forms of capital are considered, it becomes

less of a mystery as to why policy reform can be so politically and

legally painful. Cost-benefit analyses do not capture the full array of

perceived costs: the losses to human and social capital occurring

after environmental regulation (or some other economic change) are

highly salient to those possessing it, and far exceed any monetizable

amount.86 And yet, there is no basis for taking such human and

capital costs into account, or for compensating the holders of such

capital; there is no inherent societal value of human or social capital

if it is specific to an anachronistic industry.87

Overcapitalization plays a central role in the greatest

environmental problem and market failure ever: global climate

85. See Adler & Kwon, supra note 42, at 22 (stating that social capital is not

“amenable to quantified measurement”); Mankiw, supra note 2, at 293–94 (asserting that

human capital has the potential to be underestimated due to the complexity of valuing its

variables).

86. See Jessica Crowe, The Role of Natural Capital on the Pursuit and

Implementation of Economic Development, 51 SOC. PERSP. 827, 833 (2008) (inferring that

environmental regulations can have negative impacts on communities, including social

and human capital aspects); David S. Reay, Costing Climate Change, 360 PHIL.

TRANSACTIONS ROYAL SOC’Y 2947, 2948–49 (2002) (observing that cost–benefit analyses

with respect to climate change are not always able to reflect all of the social,

technological, or environmental costs of emissions).

87. See Adler & Kwon, supra note 42, at 22 (positing that social capital costs are

difficult to monetize); Mankiw, supra note 2, at 293–94 (inferring that human capital

costs are oftentimes undervalued).



change.88 Developed economies have developed largely because of

capital-intensive energy sectors.89 Thanks to sprawling energy

infrastructures, fossil fuels are efficiently extracted, transported,

and burned to generate energy at low prices. The problem is that

greenhouse gas emissions from fossil fuel-based economies

threaten to irreversibly and catastrophically warm the planet.90

Coal, the most carbon-intensive of the fossil fuels, continues to

play a central role in energy provision.91 As noted briefly above,92

strong convincing evidence exists that coal combustion, given its

social and environmental costs and its contribution to climate

change, is simply no longer worth it.93 And yet, coal combustion

persists. Most energy forecasts project an increase in coal

production.94 The world’s stock of coal-fired power plants, with a

combined value in the trillions of dollars,95 are not about to be

abandoned. And it is not only the existing stock of coal-fired

power plants that comprise the sluggish capital, but the human

and social capital that is locked into a fossil fuel-centered way of

doing things may ultimately consign the world population to

living on a climate-changed planet.

All this is to say that capital, in all its forms, has played a

special role in blocking environmental law and policy reform.

88. Nicholas Stern, the author of the Stern Review on the Economics of Climate

Change, has called climate change the “greatest market failure the world has seen.”

NICHOLAS STERN, THE ECONOMICS OF CLIMATE CHANGE: THE STERN REVIEW xviii, 4, 27

(2007) (attributing climate change to human activities); supra notes 81–82 and

accompanying text (discussing how overcapitalization helped perpetuate the harmful

effects of greenhouse emissions).

89. See Michal C. Moore, Renewable Technologies to Power and Empower the

Developing World, 16 COLO. J. INT’L ENVTL. L. & POL’Y 377, 378, 383–90 (2005) (discussing

energy’s importance to developed and developing nations).

90. For a brief review of the voluminous literature on greenhouse gases and the

risks of climate change, see HENSON, supra note 13, at 20.

91. Id. at 289–90.

92. See supra notes 23–27 and accompanying text.

93. Even the most conservative estimates of the costs of climate change, coupled

with other externalities, suggest that the benefits of this anachronistic industry are far

exceeded by the costs. See, e.g., Muller, Mendelsohn & Nordhaus, supra note 18, at 1665

(showing that coal plants have damages and costs that exceed the benefits).

94. U.S. ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY, AEO2014 EARLY RELEASE

OVERVIEW 17–18 tbl.1 (2014), available at http://www.eia.gov/forecasts/aeo/er/pdf/0383er

(2014).pdf.

95. A very rough estimate of the value of the stock of the world’s coal-fired power

plants can be obtained by multiplying world capacity, IEA ENERGY TECH. NETWORK,

COAL-FIRED POWER (2010), available at http://www.iea-etsap.org/web/E-TechDS/PDF/E01-

coal-fired-power-GS-AD-gct.pdf; Electricity Generating Capacity, U.S. ENERGY INFO.

ADMIN., U.S. DEP’T OF ENERGY (Jan. 3, 2013), http://www.eia.gov/electricity/capacity/, by a

weighted average of overnight costs, weighted by plant location, INT’L ENERGY AGENCY,

PROJECTED COSTS OF GENERATING ELECTRICITY 2010, at 60 (2010). This back-of-the-

envelope calculation is $3.6 trillion USD.



Perhaps more than even the stickiness of physical capital,

environmental policy reform has bumped up against human and

social capital that has become specialized to a specific industry or

practice. These forms of capital can come to represent the very

identity of a firm, person, or group. Destroying that capital can

appear to be tantamount to destruction of that firm, person, or

group. Resistance to reform will naturally be vigorous.

B. A Model of How Capital Impedes Reform

To see how this overcapitalization can lead to policy inertia,

consider a simple stylized example of two types of investments: a

low-capital-cost, low-benefit-stream investment, and a high-

capital-cost, high-benefit-stream investment. The goal of any

acquisition of any capital is to enjoy a stream of future benefits,

but along with a higher stream of future benefits comes the risk

that the future benefits may not fully materialize (for example,

due to an unfavorable change in the regulatory or economic

environment). Absent risk, the long-term value of the high-

capital-cost, high-benefit-stream investment is greater.96 In this

simple example, the only reason to choose a low-capital, low-

profit strategy over high-capital, high-profit strategy is the

avoidance of risk. Of course, this abstracts away from many other

determinants of capital ownership, like access to capital and

discounting, and abstracts away from many other attributes of

capital ownership, like market power and signaling benefits or

detriments (like prestige or scorn). But heuristically, it is

reasonable to work from the simplifying assumptions that the

only reason to take on more expensive capital and the attendant

risk is to generate a larger stream of benefits.

These two strategies are graphically depicted in Figure 1.

Two different firms make a capital investment at an initial

investment cost, C1, for the high-capital, high-profit strategy,

and C2, for the low-capital, low-profit strategy. The cost of

capital instantly drives down firm profitability, but capital

generates a revenue stream that increases firm profitability as

sales of the produced good generate revenues to pay back the cost

of capital. In Figure 1, the profitability of the firms, i.e., the

cumulative sum total of firm revenues and expenses, is graphed

as a function of q, the quantity of sales. This cumulative profit

line—the solid line for the high-capital, high-profit strategy—has

96. “Risk” is defined as “a chance of injury or loss.” Elke U. Weber & Richard A.

Milliman, Perceived Risk Attitudes: Relating Risk Perception to Risky Choice, 43 MGMT.

SCI. 123, 128 (1997).



a steeper slope than the dotted line than that for the low-capital,

low-profit strategy. Figure 1 represents the simple case in which

the price and operating costs are constant for all units sold, so

that profitability is linear in q. In an even simpler case, sales

would be uniform over units and also over time, so that the

horizontal axis could be time and the payback period represented

by the point in time at which the profitability crosses the

horizontal axis.

Ultimately, capital generates a cumulative profit. Assuming

the expected life of the capital in both cases to be h, the cost of

risk associated with the high-capital, high-profit strategy is r.

This also abstracts away from considerations having to do with

discounting.

Figure 1

Ex ante, the cost of risk is simply a premium that is

assumed by the firm adopting a high-capital, high-profit

strategy. The premium compensates for the risk of a regulatory

change that, in this simple case, renders the capital obsolete

and valueless. So if a firm is risk-taking, it adopts the high-

capital, high-profit strategy because the risk premium is

sufficient compensation for the risk. Relatively risk-averse firms

will opt for the low-capital, low-profit strategy. In Figures 2a

and 2b below, a regulatory change that renders the capital

obsolete and valueless occurs when the firm has sold x units.

The losses for the high-capital, high-profit strategy and the low-



capital, low-profit strategy are shown in Figures 2a and 2b

below, respectively, as L1 and L2.

Figure 2a. Figure 2b.

It is thus not the capital itself that industries, firms, and

individuals fight vigorously to protect; it is the expected stream

of benefits that inspires such vigorous defense. It so happens that

most of the time we should expect that the more expensive the

capital, the greater the stream of benefits. But that would be an

imprecise conclusion. Expected benefits could well be capitalized

into a valuation of capital, but far from being universally true,

there is ample reason to suspect that capital is rarely perfectly

priced to reflect the expected stream of benefits.97 Ultimately, it

is the hoped-for stream of benefits that a firm, having acquired

capital, will struggle to protect; it will expend any amount up to

the value of the hoped-for but lost stream of benefits.98

Obviously, the loss suffered by an unfavorable change in the

legal or economic environment is greater in the high-capital,

high-profit scenario; there is a larger stream of benefits to lose.

All other things being equal, as long as the high-capital, high-

profit strategy yields higher marginal profits (again, this is

assumed, because in this simple model there would otherwise be

no reason to expend higher amounts of capital), the loss L1 will

always be greater than the loss L2.

What is nonintuitive about the role of capital is the ex post

amplification of the importance of the initial investment. Ex ante,

the equilibrium cost of the risk is r. Ex post, however, once the

97. See, e.g., Franklin M. Fisher, On the Misuse of the Profits–Sales Ratio to Infer

Monopoly Power, 18 RAND J. ECON. 384, 385, 392–94 (1987).

98. See Patrick Gaughan, Paul Lerman & Donald Manley, Measuring Damages

Resulting from Lost Functionality of Systems, J. LEGAL ECON., July 1993, at 11, 14–17

(describing capital budgeting techniques which weigh the current investment expenditure

with the future value of the stream of benefits that investment will likely produce).



capital is sunk, the stake is not just r, nor is it just the cost of

capital. After the initial investment in capital, the risk of loss is

equal to the expected stream of benefits. In order to combat such

a loss, the owner of capital will expend any amount of money up

to the expected loss (L1 or L2), which could well exceed the cost

of the capital (C1 or C2). So the amount of money spent on

resisting policy change can be highly sensitive to initial decisions

on capital investment. Just a subtle nudge, such as that provided

by an obscure legal provision, can magnify differences in capital

investment and lead to a very different world in terms of

incentives to resist policy change.

Whether a firm chooses the high-capital, high-profit strategy

or not thus has profound implications for economic efficiency. Put

simply, the greater the value of the capital, the greater the threat

of obsolescence for the firm owning the capital, and the greater

efforts it will undertake to resist reform. An overcapitalized

society will be a society in which there are more efforts to resist

reform. Because capital in its various forms regularly experiences

obsolescence,99 a capital-protecting society is a society that is less

agile and less receptive to reform that threatens the value of that

capital.

Note that losses L1 and L2 are only fully realized if the

capital is “stranded,” or unsusceptible of redeployment. More

generally, the problem of avoiding loss can be considered as a

problem with switching costs, and the losses L1 and L2 can be

more generally considered the net costs of being forced

(economically or by regulation) to switch capital to a new use. L1

and L2 are thus the lesser of switching costs and the complete

economic loss of a stream of benefits.

This theory of capital-protecting offers insight into a further

subtlety. When there is human or social capital involved, the

monetization of a stream of benefits could appear quite small in

comparison with the value of physical capital. But when the stream

of benefits generated by that human or social capital is perceived

(accurately or not) to be the only possible source of income, the

marginal value of the stream of benefits generated by that human

or social capital can be extremely high to the capital holder, perhaps

even infinite. Defense of this kind of capital could be very vigorous.

In sum, capital will always pose a barrier to policy reform

because policy reform will always take place when some capital

99. For example, one form of capital discussed in this Article, nuclear power plants,

frequently becomes obsolete. See, e.g., Stephen Maloney, PLEX: Nuclear Plant Life

Extension or Extinction?, PUB. UTIL. FORT., Nov. 15, 1992, at 15, 19–20 (discussing

SONGS 1, a nuclear power plant originally built in 1967 that has since become obsolete).



assets have some remaining life and have the capacity to

generate a prospective stream of benefits.100 Switching costs are

never zero, so redeployment will always be costly.101 A normal

economy will thus always generate some resistance to policy

change. But the problem identified in this Article is that legal

rules have biased capital decisions toward larger capital, larger

profits, and concomitantly larger risks of obsolescence. Having

sunk a larger investment into capital, owners of that capital will

resist policy reform with greater effort. A systemic overpromotion

and overprotection of capital is thus creating a greater drag on

policy reform than would otherwise be the case.102

IV. THE ROLE OF LAW AND LAWMAKING IN PROMOTING AND

PROTECTING CAPITAL

What exactly is the role of law in this story of policy inertia?

The focus of this Article is on the role that law and policy play on

the antecedent conditions that give rise to an overcapitalized

economy, thereby generating policy inertia. Law and policy

create overcapitalized economies in two ways: (i) laws that

overpromote the formation of capital, and (ii) rules that

overprotect capital from changes in its legal or economic

environment.

Laws that promote the formation of capital create policy

inertia indirectly because they lower the cost of capital and induce

larger investments than would otherwise occur.103 Capital-friendly

rules thus enlarge capital stock and therefore increase the

incentives to resist reform. In short, capital-friendly rules impede

policy reform by increasing the private costs of policy reform.104

100. See, e.g., Robertson, supra note 81, at 168 (noting that existing capital may pose

barriers to reform when legislators conclude that it is more economically efficient to allow

existing facilities to operate under less stringent (but environmentally harmful) standards

and take advantage of their remaining capital rather than render them obsolete).

101. See Mark R. Patterson, Product Definition, Product Information, and Market

Power: Kodak in Perspective, 73 N.C. L. REV. 185, 199 (1994) (“[E]very purchaser of a

product that requires some capital investment incurs [switching costs]. Whenever such a

product still has useful life, that remaining life will have value that will be costly to

sacrifice in switching to a different product.”).

102. Grandfather clauses “place[] the cost of the compliance burden on . . . those who

may not be aware that they will be affected, and therefore cannot combat the regulatory

enactment.” Robertson, supra note 81, at 169. This has the effect of preventing policy

reform, as “legislators may be able to enact legislation which, without the inclusion of a

protective grandfather clause, would be politically impossible.” Id.

103. See, e.g., Ellen Lapson & Richard Hunter, The Future of Fuel Diversity: Crisis or

Euphoria?, PUB. UTIL. FORT., Oct. 2004, at 60, 64 (explaining how, through legislation,

Congress can “reduce risk and lower the cost of capital”).

104. See supra Part III.A (explaining how overcapitalization impedes environmental

reform).



The latter mechanism, rules that overprotect capital,

prolong the life of capital even when environmental harms

outweigh economic benefits.105 For instance, a rule

grandfathering existing capital into older, less stringent

regulatory schemes is one example.106 Note that this latter

mechanism has a doubly pernicious effect: it entrenches existing

capital regardless of its inherent social value, and it also

produces an antecedent effect of providing assurances to new

capital investors that their capital will also be similarly protected

from unfavorable changes in legal rules.107 Investors will

overinvest knowing that legal leniencies will at least partially

insure them against obsolescence.

It is worth bearing in mind that the incentives for capital

formation can be quite small.108 All that is needed is something to

change the decision environment, not finance the undertaking. A

small subsidy can induce the formation of capital by just tilting a

close decision. It can also induce an upgrade in capital in a

situation where a more modest investment would otherwise be

privately optimal.

This Article will discuss five ways in which law and policy

overpromote the formation of capital, and overprotect obsolescent

capital: (1) tax benefits for energy industries; (2) tax benefits for

mining industries; (3) electric utility regulation;

(4) grandfathering; and (5) regulatory takings jurisprudence.

This Part will also discuss the special political application of this

theory to human and social capital.

A. Tax Benefits for Energy Industries

Clearly, federal and state governments have subsidized the

formation of energy capital through tax benefits for a long time

(by some estimates, a century).109 Equally clearly, subsidies have

105. See, e.g., Robertson, supra note 81, at 168–70 (asserting that laws, such as

“grandfather clauses,” have overprotected capital at the expense of environmental harm).

106. See id. at 168 (“[Grandfather clauses] allow some existing facilities to operate

under less stringent standards.”).

107. Id. at 168–70 (describing the “perverse” effects of grandfather clauses).

108. See, e.g., Cont’l Tel. Co. of Pa. v. Pa. Pub. Util. Comm’n, 548 A.2d 344, 346 (Pa.

Commw. Ct. 1988) (recalling that merely normalizing deferred tax expenses for a utility

was designed to “provide incentives for capital formation”); see also infra Part III.B

(setting forth a simple model showing that small incentives can lead to large increases in

capital investment).

109. The expensing of intangible drilling and exploration costs for independent oil and

gas producers has been allowed since 1913. ROBERT PIROG, CONG. RESEARCH SERV., R42374,

OIL AND NATURAL GAS INDUSTRY TAX ISSUES IN THE FY2013 BUDGET PROPOSAL 3 (2012)

[hereinafter CRS REPORT], available at http://budget.house.gov/uploadedfiles/crsr42374.pdf; see

26 U.S.C. § 263(c) (2012) (current tax code provision allowing such expensing).



resulted in the formation of excess energy capital.110 But defining

a subsidy is tricky, especially in the energy industry, in which

there are both economies and diseconomies of scale, and

sometimes the need for a regulated monopoly. Is the regulation

and price-setting of electricity an energy subsidy? Also, certain

tax advantages inure to the benefit of many industries, of which

energy is just one;111 would that be an energy subsidy? The

definitional problems abound.

This Article will focus on subsidies that: (i) involve direct

payments from the federal government to an energy firm, (ii) reduce

or defer the tax liability for an energy firm but do not apply to

nonenergy firms, or (iii) provide some indirect but clearly financial

benefit, such as a loan guarantee. These are the types of subsidies

that are most likely to lower the cost of capital and induce excess

formation of capital.112

Some subsidies may promote the formation of capital that

confers positive externalities. For example, subsidizing the

construction of electricity transmission lines is more akin to the

provision of a public good113 that might warrant subsidization. In

such cases, it might be hard to say if the capital being formed is

“excess,” as the public-good nature of the problem suggests that

there would typically be a shortage of capital.114 Those subsidies are

generally not targeted in this Article, and in fact, are considered

below as the kind of subsidy that might be socially beneficial.

What is very much the target of this Article is the kind of

energy subsidy that seeks to simply lower the price of energy.

110. See James C. Cox & Arthur W. Wright, The Cost-Effectiveness of Federal Tax

Subsidies for Petroleum Reserves: Some Empirical Results and Their Implications, in

STUDIES IN ENERGY TAX POLICY 177, 188 (Gerard Brannon ed., 1975) (finding that special

tax provisions induced the petroleum industry to maintain larger investments in proven

reserves); Walter J. Mead, The Performance of Government in Energy Regulations, 69 AM.

ECON. REV. (PAPERS & PROC.) 352, 352 (1979) (“These tax subsidies [in the form of

percentage depletion allowance and expensing of intangible drilling costs] led to increased

capital flows into exploration.”).

111. See, e.g., Philip E. Harris, The Domestic Production Activities Deduction, 12

DRAKE J. AGRIC. L. 101, 103 (2007) (referencing Internal Revenue Code § 199 regarding

the Domestic Production Activities Deduction, which permits a taxpayer to deduct a

percentage of their income produced through domestic production activities, regardless of

industry).

112. See Erik F. Gerding, Deregulation Pas De Deux: Dual Regulatory Classes of

Financial Institutions and the Path to Financial Crisis in Sweden and the United States,

15 NEXUS 135, 144–45 (2010) (noting that subsidies may afford lower cost of capital).

113. TOM TIETENBERG & LYNNE LEWIS, ENVIRONMENTAL AND NATURAL RESOURCE

ECONOMICS 31 (9th ed. 2012); Michael H. Dworkin & Rachel Aslin Goldwasser, Ensuring

Consideration of the Public Interest in the Governance and Accountability of Regional

Transmission Organizations, 28 ENERGY L.J. 543, 559 (2007).

114. See discussion infra Part V (noting the necessity of adequate electric

transmission capabilities).



While low energy prices do stimulate economic development,

there is no reason to believe that energy would be undersupplied

absent a subsidy.115 Energy is not a public good.116

What then, are the subsidies that have led to the

formation of excess energy capital? The coal industry has long

enjoyed a privileged place in American energy policy.117 Most

coal has been combusted for electricity generation, which,

because it has predominantly been a regulated utility, has

enjoyed a special set of legal protections that have resulted in

a vastly overcapitalized industry.118 But mining coal itself is

also a privileged activity. Coal mining rights are often owned

and leased, and disposition of the coal typically results in a

royalty payment.119 For individual owners receiving royalty

payments, the royalty payments can be taxed at the lower

capital gains tax rate.120 While ordinary lease payments (such

as for residential or commercial property) must be taxed as

income,121 coal mining rights are considered a capital asset

that can be taxed at the lower rate.122 This brings marginal

coal mines into production and expands the attendant

infrastructure to extract and transport the coal.

115. See, e.g., Earl Blumenauer, Introduction, 15 LEWIS & CLARK L. REV. 315, 319

(2011) (noting that, while some emerging energy technologies may benefit from subsidies,

traditional energy subsidies do not affect energy price or supply).

116. Note that this is not the same thing as making the argument that failing to

internalize environmental externalities is tantamount to a subsidy. The policy remedy of

an environmental externality is the imposition of a Pigouvian tax, not the withdrawal of a

subsidy. Kyle D. Logue & Joel Slemrod, Of Coase, Calabresi, and Optimal Tax Liability,

63 TAX L. REV. 797, 829 (2010) (defining a Pigouvian tax as one “designed to correct

externalities”). The thrust of this Article is that certain legal institutions have created

antecedent conditions that overpromote capital and once formed, overprotect. It is

different to say that an omission such as the failure to impose a Pigouvian tax is part of

that legal infatuation with capital.

117. FREESE, supra note 23, at 130 (“In the United States, though, still in its

formative stages, coal would have an even greater impact on the political power structure

of the nation [as compared to Britain].”).

118. Peter S. Glaser, F. William Brownell & Victor E. Schwartz, Managing Coal:

How to Achieve Reasonable Risk with an Essential Resource, 13 VT. J. ENVTL. L. 177, 186

(2011); infra Part IV.C.

119. See, e.g., Willits v. Peabody Coal Co., 332 S.W.3d 260, 261–62 (Mo. Ct. App.

2010) (involving a situation in which coal mining rights were leased with an agreement to

pay royalties upon the gross realization of the coal mined); Sam P. Burchett, The

Applicant Violator System in Transition, 21 N. KY. L. REV. 555, 559 (1994) (discussing the

structure of the lessor–lessee relationship in coal mining leases).

120. 26 U.S.C. § 631(c) (2012). Section 631 also applies to timber and iron ore. Id.

§ 631(b)–(c).

121. Id. §§ 1(c), 61(a)(3), (6), 63(a) (including royalty payments and monies from

property dealings in “gross income” and therefore in “taxable income,” which is taxed at

ordinary tax rates).

122. Id. § 631(c).



The other fossil fuels, oil and natural gas, have also been

heavily subsidized. The Internal Revenue Code has long

granted preferential tax treatment to entities undertaking

capital projects for the exploration and extraction of oil and

natural gas.123 Independent oil and gas producers—i.e., small,

nonintegrated oil and gas producers124—are permitted to deduct

from income taxes a “percentage depletion” of their oil or gas

deposit basis rather than a cost depletion method of

accounting.125 That is, rather than try to estimate the value of

their deposit and deduct from their annual income taxes, they

may simply deduct fifteen percent of their gross income as a

generous proxy for the depreciated value of their oil and gas

deposits.126 So long as the expected life of the oil and gas well is

greater than 6.67 years (100 ÷ 15), this represents an

accelerated depreciation of their asset, and a financial benefit in

the form of a deferred tax liability.127 In addition, independent

producers are permitted to take a more generous deduction for

“intangible drilling costs,” generally defined as a cost that has

no salvage value and is “incident[al] to and necessary for the

drilling of wells and the preparation of wells for the production

of oil and gas.”128 These expenses expressly include “wages, fuel,

repairs, hauling, supplies, etc.,” that are required for the site

preparation and drilling of wells.129 Seventy percent of

intangible drilling costs are deductible from income in the year

in which they are incurred, and the remaining thirty percent

depreciated over a five-year period.130 This, too, represents a

significant benefit in the form of a deferred tax liability. Finally,

geological and geophysical exploration activities may be

depreciated over an accelerated two-year schedule, again

producing a frontloaded depreciation schedule and an effective

123. See, e.g., id. § 263(c) (allowing expensing of intangible drilling and exploration

costs for independent oil and gas producers); CRS REPORT, supra note 109, at 3 (“The

expensing of intangible drilling costs has been part of the federal tax code since 1913.”).

124. The Internal Revenue Code defines oil and gas producers as independent if,

among other requirements, they have no more than $5 million in gross receipts in a given

year. 26 U.S.C. § 613A(d)(2).

125. Id. § 613A(c)–(d); Treas. Reg. § 1.612-4 (2013); CRS REPORT, supra note 109, at

5.

126. CRS REPORT, supra note 109, at 5.

127. Id.

128. 26 U.S.C. § 263(c); Treas. Reg. § 1.612-4; CRS REPORT, supra note 109, at 1;

John S. Lowe, Analyzing Oil and Gas Farmout Agreements, 41 SW. L.J. 759, 766 (1987)

(internal quotation marks omitted).

129. Treas. Reg. § 1.612-4(a)–(b).

130. CRS REPORT, supra note 109, at 3.



tax liability deferral.131 These three subsidies are, according to a

2011 report by the U.S. Energy Information Administration,

three of the most valuable subsidies for the oil and gas industry,

estimated by the EIA to be $980 million, $400 million, and $150

million, respectively, for 2010, for a total of about $1.53 billion.132

Over time, the subsidies appear even more generous. A

literature-based study done by a venture capital firm specializing

in energy investments estimates that from 1918 to 2009, oil and

gas firms have received $447 billion in subsidies, measured in

2010 dollars.133

It is difficult to even guess at the effect of this infusion of

money on capital formation in the energy industry, and on policy

resistance. Studies have clearly shown a higher level of

investment induced by these tax benefits.134 It is another matter

to determine exactly how much these subsidies have bloated the

capital stock. But $447 billion over 91 years—an average of $4.9

billion per year—is a lot of money to inject into even the

mammoth oil and gas industries.

It is worth remembering two things. First, because a subsidy

need only subtly nudge capital decisions, the capital-bloating

131. See id. at 6 (noting that the current law permits independent producers to

depreciate geological and geophysical costs over a period of only two years).

132. U.S. ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY, DIRECT FINANCIAL

INTERVENTIONS AND SUBSIDIES IN ENERGY IN FISCAL YEAR 2010, at 18 tbl.6 (2011)

[hereinafter EIA 2010 REPORT], available at http://www.eia.gov/analysis/requests/

subsidy/pdf/subsidy.pdf. It is well worth noting that estimates of the value of these

subsidies, as well as others, vary greatly. In recent budget negotiations, President Obama

proposed a budget for 2013 that would have eliminated the percentage depletion

allowance and the expensing of intangible drilling costs, and lengthened the two-year

amortization period for geological and geophysical activities. CRS REPORT, supra note

109, at 1–2 & tbl.1. The Congressional Research Service estimated the cost savings of

these changes to be $13.9 billion, $11.5 billion, and $1.4 billion, all over ten years. Id. at

5–7.

133. See NANCY PFUND & BEN HEALEY, DBL INVESTORS, WHAT WOULD JEFFERSON

DO? THE HISTORICAL ROLE OF FEDERAL SUBSIDIES IN SHAPING AMERICA’S ENERGY

FUTURE 29 (2011), available at http://i.bnet.com/blogs/dbl_energy_subsidies_paper.pdf.

134. See, e.g., Cox & Wright, supra note 110, at 188–89 (“Federal tax provisions for

petroleum have had a statistically significant effect in increasing investment in petroleum

reserves.”); Mead, supra note 110, at 352 (reporting how certain tax subsidies “led to

increased capital flows into [oil and gas] exploration”). According to the trade group Texas

Alliance of Energy Producers, President Obama’s similar proposal for fiscal year 2011 to

eliminate these four tax benefits (and some other, much less expensive ones) would have

reduced oil and gas investment by $26 billion over ten years. TEXAS ALLIANCE OF ENERGY

PRODUCERS, OIL & GAS PROVISIONS IN PRESIDENT OBAMA’S PROPOSED 2011 BUDGET (on

file with Houston Law Review). But there is no study or data to support these estimates.

Also, given the similarity of this figure with the other estimates (that of the CRS

estimates for the President’s 2013 proposal, CRS REPORT, supra note 109, and the EIA

estimates of the cost for fiscal years 2007 and 2010, EIA 2010 REPORT, supra note 132, at

18 tbl.6, these estimates are more likely just the group’s own estimates of the value of the

withdrawn subsidies, not the absolute amount of withdrawn capital investments.



effect of a subsidy could vastly exceed the cost of the subsidy. So

$4.9 billion could well have generated excess capital in an

amount much greater than $4.9 billion. Second, the subsidy itself

is a source of funding for resistance to policy reform. If even a

small fraction of $4.9 billion were spent on litigation and

lobbying activities, the effect on public policy would have been

profound.

President Obama has repeatedly proposed to phase out or

eliminate subsidies for oil and gas companies.135 To the extent

that these subsidies stimulate the formation of capital, these are

good steps. There is in most cases nothing remotely resembling a

public good in the oil and gas industry warranting subsidization.

But the mistake that the Obama Administration makes—like all

preceding modern administrations—is to try to right a wrong by

subsidizing competing, cleaner energy sources such as renewable

energy.136 Because renewable energy does not impose the

negative environmental externalities imposed by the extraction

and combustion of fossil fuels, it would seem to stand to reason

that it is worth subsidizing their production so as to place fossil

fuels and renewable sources on a level playing field.

With an exception discussed below,137 this is mistaken

thinking. A subsidy lowers the effective cost of capital and

promotes the formation of new capital.138 The problem with

promoting capital investment in nonfossil fuel energy sources is

that it fails to learn from our past mistakes in promoting fossil

fuel energy sources. How do we know this is the “right” energy

technology? What will happen if information emerges pointing to

135. See OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, BUDGET OF

THE U.S. GOVERNMENT: FISCAL YEAR 2011, at 161–62 tbl.S-8, available at

http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf (showing

the budgetary plan to phase out fossil fuel tax preferences); OFFICE OF MGMT. & BUDGET,

EXEC. OFFICE OF THE PRESIDENT, FISCAL YEAR 2012 BUDGET OF THE U.S. GOVERNMENT, at

185–86 tbl.S-8, available at http://www.whitehouse.gov/sites/default/files/omb/budget/

fy2012/assets/budget.pdf (same); OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE

PRESIDENT, FISCAL YEAR 2013 BUDGET OF THE U.S. GOVERNMENT, at 221–22 tbl.S-9,

available at http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/

budget.pdf (same).

136. See, e.g., Paul M. Kiernan et al., International Energy and Natural Resources,

44 INT’L LAW. 367, 375–76 (2010) (discussing the Obama Administration’s support for

renewable energy); Report of the Renewable Energy and Demand-side Management

Committee, 30 ENERGY L.J. 273, 273–74 (2009) (discussing the Energy Improvement and

Extension Act of 2008, signed into law by President George W. Bush).

137. See infra Part IV.B (discussing tax benefits for the mining industry).

138. See, e.g., Note, Reassessing Rent Control: Its Economic Impact in a Gentrifying

Housing Market, 101 HARV. L. REV. 1835, 1847 (1988) (contending that government

subsidies lower the effective cost of capital activities, such as low income house

construction).



alternative energy sources that are even cleaner? Promoting the

formation of capital in specific renewable energy technologies

runs the risk of locking in these technologies for longer than

would be optimal.139 Future policy reform efforts to usher in

newer and even better technologies will be met with resistance

by the owners of this capital.

Energy policies in pursuit of cleaner alternatives to fossil fuel

combustion are pursuing this misguided course. Federal energy

subsidies have increased since 2007, and although they seek to

correct a historical imbalance between fossil fuel and renewable

energy technologies,140 they repeat the historical mistake of trying

to accomplish an objective by exhorting the formation of capital.

Federal energy subsidies more than doubled from 2007 to 2010,

from almost $18 billion to more than $37 billion, and nearly all of

that increase has been due to subsidies for nonfossil energy

sources.141

In some aspects, new subsidies for renewable energy

providers are even more capital-intensive than those for oil and

gas. Producers of electricity from renewable energy sources have

long benefited from a production tax credit, a unitary subsidy for

each kilowatt-hour of electricity produced using a “qualified”

production method.142 Section 1102 of the American Recovery and

Reinvestment Act of 2009 (ARRA) sweetens things, allowing

renewable energy providers to elect to take an Investment Tax

Credit instead of the production tax credit, thereby frontloading the

subsidy and immediately reducing the cost of capital, rather than

allowing for a potentially larger stream of subsidy payments.143 But

even better still, for certain renewable energy providers,144 Section

1603 of the ARRA offers a cash grant of ten or thirty percent in lieu

of the investment tax credit and the production tax credit,145 the

139. See Nina Robertson, Bruce Rich & Lynsey Gaudioso, As the World Burns: A

Critique of the World Bank Group’s Energy Strategy, 43 ENVTL. L. REP. 10,760, 10,768

(2013) (“Every new fossil fuel investment locks in [the technology] for decades.”).

140. PFUND & HEALEY, supra note 133, at 29 (showing a substantial imbalance

among the cumulative historical subsidies for oil and gas, nuclear energy, biofuels, and

renewable energy sources).

141. EIA 2010 REPORT, supra note 132, at xi tbl.ES1.

142. 26 U.S.C. § 45(a) (2012).

143. American Recovery and Reinvestment Act of 2009 (ARRA), Pub. L. No. 111-5,

§ 1102, 123 Stat. 115, 319–20 (as amended by the Tax Relief, Unemployment Insurance

Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111-312, § 707, 124 Stat. 3296,

3312).

144. Solar, landfill gas, trash, geothermal, wind, hydro, biomass, marine and

hydrokinetic energy sources qualify. ARRA § 1603(d)(1) (citing 26 U.S.C. § 45(d)(1)–(4),

(6)–(7), (9), (11)).

145. Id. § 1603(a)–(b).



advantage over a tax credit being that there need not be any income

against which to offset a tax credit.146 The Section 1603 program

has been “enormously popular,” with expenditures for the grant

totaling $4.2 billion in 2010,147 and far surpassing the costs of the

production tax credit and the investment tax credit, which were

$1.5 billion and $130 million, respectively, in 2010.148 It was even

an explicit goal of ARRA to inject money into the economy to assist

in the economic recovery.149

In addition, the Department of Energy (DOE) operates

several loan guarantee programs for qualifying projects or firms.

Section 406 of the ARRA, amending Title XVII of the Energy

Policy Act of 2005, provides for loan guarantees for “[r]enewable

energy systems,” “[e]lectric power transmission systems,” and

“[l]eading-edge biofuel projects.”150 By the end of 2010, DOE

had issued over $25 billion in loan guarantees.151 It was under

this program that DOE issued a loan guarantee to the failed

solar energy company, Solyndra, which brought controversy to

the program.152 Adding to the controversy, DOE is authorized

to guarantee 100% of a loan, not a more traditional fraction,

like eighty percent.153 Some funding was also issued to aid in

the construction of nuclear power plants.154 Overall, spending

on renewable energy technologies was much greater than

spending on fossil fuel technologies: more than $14 billion to

just over $4 billion.155

146. See John A. Herrick & Cara S. Elias, Federal Incentives for Clean Energy After

Solyndra: A Post-Recovery Act Precipice, 87 N.D. L. REV. 625, 678 (2011) (“By allowing

renewable energy investors to monetize the related tax credits, it has created an avenue

for investment in projects that would otherwise have been blocked during the economic

lull following the Recovery Act due to the dearth of investors with tax liability for the tax

credits to offset.”).

147. EIA 2010 REPORT, supra note 132, at 30.

148. Id. at 13 tbl.3.

149. ARRA § 3(a)(1).

150. Id. § 406.

151. EIA 2010 REPORT, supra note 132, at 59.

152. See, e.g., Hilary Kao, Beyond Solyndra: Examining the Department of Energy’s

Loan Guarantee Program, 37 WM. & MARY ENVTL. L. & POL’Y REV. 425, 475–78 (2013)

(describing the controversy surrounding the loan guarantee program after “Solyndra

experienced financial difficulties despite having received the DOE loan guarantee

commitment”); Ashley Southall, House Passes Solyndra Act Aimed at Obama, CAUCUS

(Sept. 14, 2012, 5:46 PM), http://thecaucus.blogs.nytimes.com/2012/09/14/house-passes-

solyndra-act-aimed-at-obama/?ref=solyndra&_r=0.

153. See EIA 2010 REPORT, supra note 132, at 64 (explaining that, initially, DOE

could guarantee a more traditional eighty percent of a loan, but by the time the final

rulemaking was passed, DOE was authorized to guarantee the full amount).

154. See id. (describing how, with the passage of the Fiscal Year 2008 Appropriations

Act, DOE was authorized to allocate $18.5 billion in loan guarantees to nuclear plants).

155. Id. at xiii tbl.ES2.



The goal of trying to rapidly ramp up renewable energy

production is certainly laudable, especially in the face of an

inability to pass comprehensive climate legislation that might

achieve an energy transition in a more holistic way.156 It is still

troubling, however, to consider how much capital is being formed,

with relatively little known about the relative merits of wind

energy as opposed to other technologies that may emerge in the

next several years. From 2000 to 2010, net generation of

electricity from wind power rose from 6 billion kilowatt-hours to

95 billion,157 and net summer capacity for wind energy grew from

just about 8 gigawatts in 2005 to over 39 gigawatts in 2010.158

This is troubling because the technology of electricity production

is constantly evolving. Only recently did Congress suddenly

notice the potential of hydrokinetic energy, the use of wave action

to generate electricity.159 Only recently has low-tech solar

thermal energy gained attention,160 as it has become competitive

much more quickly than the previously favored solar technology,

photovoltaics.161 If a new and better renewable energy

technology is discovered, what will be the policy response of

wind energy developers that have invested billions of dollars?

As I have argued elsewhere, the correct response to the

environmental externality of emissions from fossil fuel-fired

sources is not to try to subsidize all that is not fossil fuels.162 If

there is a negative environmental externality, the right

approach is to tax the negative externality, not to subsidize

everything else. It seems politically more palatable to

156. Hari M. Osofsky, Diagonal Federalism and Climate Change Implications for the

Obama Administration, 62 ALA. L. REV. 237, 296 (2011) (“Congress has failed to pass

major climate change legislation . . . .”).

157. EIA 2010 REPORT, supra note 132, at xx tbl.ES5.

158. U.S. ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY, ELECTRIC POWER ANNUAL

2010, at 6 tbl.1.1B (2011), available at http://www.eia.gov/electricity/annual/html/table1.

1b.cfm.

159. FERC Issues First Pilot License for Tidal Power Project in New York, FED.

ENERGY REGULATORY COMM’N, http://www.ferc.gov/media/news-releases/2012/2012-1/01-

23-12.asp (last updated Jan. 23, 2012) (illustrating that hydrokinetic projects are a recent

endeavor); Hydrokinetic Projects, FED. ENERGY REGULATORY COMM’N, http://www.ferc.gov/

industries/hydropower/gen-info/licensing/hydrokinetics.asp (last updated Jan. 22, 2014).

160. U.S. ENERGY INFO. ADMIN., supra note 158, at 6 tbl.1.1.B (showing a steady

increase in net capacity of solar thermal energy from 2000 to 2010); S. Mekhilef, R. Saidur

& A. Safari, A Review on Solar Energy Use in Industries, 15 RENEWABLE & SUSTAINABLE

ENERGY REVIEWS 1777, 1778–79 (2011), available at http://www.sciencedirect.com/

science/article/pii/S1364032110004533# (“Due to the global energy shortage and

controlling harmful environmental impacts, application of solar energy has [been]

receiving much attention in the engineering sciences.”).

161. HSU, supra note 7, at 43.

162. See id. at 36–37 (“Government subsidization should be viewed with skepticism,

rather than being the presumptive first option.”).



subsidize “good” industries than it is to tax “bad” industries,163

but the politically expedient approach is less efficient.164 In the

context of energy policy, a much more effective and efficient

policy tool than subsidization is a carbon tax.165 Among other

problems with the pushing-on-a-string effectiveness of trying

to prop up all that is putatively good,166 subsidizing “good”

industries promotes the excessive formation of capital. A tax

on a negative environmental externality is capital neutral.167

Capital formed in one industry (e.g., wind energy) because

negative externalities are taxed in another industry (coal, oil,

or natural gas) will not be as likely to become obsolete because

it is responding to a technology-neutral price signal, not a

political judgment.

B. Tax Benefits for Mining Industries

There is one industry that may benefit from even greater

taxpayer generosity than the energy sector: the hard rock

mining industry. Few industries create as many or as severe

environmental externalities as the mining industry.168 But

apparently following in the same industrial-development, low-

commodity-price rationales that animate energy subsidies, a

variety of favorable tax provisions facilitate the formation of

163. See id. at 118–23 (“[P]ublic opinion polls seem to show that the American public

strongly favors subsidy programs to reduce greenhouse gases but strongly opposes carbon

taxes or gasoline taxes . . . .”).

164. See id. at 53–59 (critiquing the United States’ track record with respect to

making “strategic decisions” and commenting how it is “too easy and too dangerous to fall

into the trap of thinking that governments can ‘fix’ the problem directly, funding a

potential ‘home run’ or ‘gamechanger’”); see also MCKINSEY & CO., PATHWAYS TO A LOW-

CARBON ECONOMY 73 (2009), available at www.mckinsey.com/~/media/mckinsey/dotcom/

client_service/sustainability/cost curve pdfs/pathways_lowcarbon_economy_version2.ashx

(illustrating how the use of subsidies can cause waste).

165. See HSU, supra note 7, at 34–37 (comparing the effects of taxing carbon versus

subsidizing renewable energy); MCKINSEY & CO, supra note 164, at 19, 73 (suggesting

that a carbon tax would help reduce emissions and discussing the negative externalities of

subsidies).

166. See HSU, supra note 7, at 34–37 (expressing some limitations of subsidization).

167. See id. at 45 (labeling a carbon tax as “capital-neutral” because it “does not

encourage the formation of expensive physical capital that would inhibit future changes

in production”).

168. See, e.g., PRINCIPLES FOR RESPONSIBLE INVESTMENT, UNITED NATIONS ENV’T

PROGRAM, UNIVERSAL OWNERSHIP: WHY ENVIRONMENTAL EXTERNALITIES MATTER TO

INSTITUTIONAL INVESTORS 27 fig.3 (2011), available at http://www.unpri.org/files/

uop_long_report.pdf (listing “Industrial Metals & Mining” as the third-highest industry

sector in terms of environmental costs); Emissions of Greenhouse Gases in the U.S., U.S.

ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY (Mar. 31, 2011), http://www.eia.gov/

environment/emissions/ghg_report/ghg_methane.cfm (“Natural gas systems and coal

mines are the major sources of methane emissions in the energy sector.” (citation

omitted)).



mining capital. Exploration and development expenses for

mining companies, unlike for oil and gas companies, are

deductible in full in the year those expenses are incurred.169

The deduction is required to be recaptured when the mine goes

into production, but many miners are able to avoid this taxable

event by avoiding “production” status.170

In Canada, where mining is a centrally important

industry,171 small, start-up mining companies, known as

“juniors,” can pass through capital losses—losses that cannot

be deducted from their income because juniors have no

income—up to acquiring companies.172 The advantage of

having this benefit of “flow-through” shares is that a tax

deduction is essentially sold from an entity that has no income

against which to deduct expenses, to a larger entity that does.

Thus, the tax benefit is commodified and made into a valuable

asset, creating a premium for shares of juniors and stripping

away significant risk in an inherently risky business. From

1987 to 1991, $2.5 billion (CAD) of flow-through shares were

exchanged, accounting for sixty percent of the funding for

mining exploration over that period.173 Empirical research

suggests that this has led to capital overinvestment in the

mining industry and below-market returns to mining

capital.174 It was the stated policy of the Canadian government

that the flow-through share device should promote equity

investments in mining and petroleum companies in Canada,

and it should provide financing assistance to junior,

169. Compare 26 U.S.C. § 617(a)(1) (2012), with 26 U.S.C. § 461(i)(2), and 26 U.S.C.

§ 263(a), (c).

170. Treas. Reg. § 1.617-3 (2013).

171. Mining, quarrying, and oil and gas extraction together represented eight

percent of the Canadian economy, and roughly twenty-seven percent of the Canadian

goods-producing economy in 2012. Canadian Industry Statistics: Gross Domestic Product

(GDP): Canadian Economy (NAICS 11-91), INDUS. CAN., http://www.ic.gc.ca/eic/site/cis-

sic.nsf/eng/h_00013.html#vla2b (last updated Dec. 18, 2013).

172. Income Tax Act, R.S.C. 1985, c. L-1 §§ 40(1)(b), 44.1(8)(b), 110.6(2.1)(d) (Can.

5th Supp.); KPMG IN CANADA, KPMG, A GUIDE TO CANADIAN MINING TAXATION 7, 12

(Sept. 2011), http://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Docu

ments/5539_KPMG_A%20Guide%20to%20Canadian%20Mining%20Taxation_web.pdf; see

also Christopher Berry, How to Blow Up a Start Up—The Biggest Financing Pitfall for

Entrepreneurs, FORBES (July 16, 2012), http://www.forbes.com/sites/discoveryinvesting/

2012/07/16/how-to-blow-up-a-start-up-the-biggest-financing-pitfall-for-entrepreneurs-2/

(discussing how small start-up mining companies are known as juniors and “generate no

cash flow, revenue, or earnings”).

173. Gordon J. Lenjosek, A Canadian Tax Incentive for Equity Investments in Mining

and Energy Companies, NEW DIRECTIONS FOR EVALUATION, Fall 1998, at 117, 120.

174. See id. at 127 (reporting that “overheating” in the mining industry caused

incremental drilling activity to be lower than incremental mining exploration spending).



nontaxpaying, companies.175 It has apparently succeeded in

this respect.176

The extraction of valuable deposits has obviously been vital

in developing the economies of wealthy countries.177 These

sectors are particularly capital-intensive and foundational in that

their abundance seems to be a predicate to economic growth, so

perhaps they are particularly tempting targets for subsidization.

But this is precisely the superficial and specious growth

paradigm that retards policy reform. It is unnecessary, and

indeed potentially very harmful, for government policy to actively

stimulate economic growth by promoting the formation of capital.

The energy and hard rock mining industries stand as prominent

examples of this bias.

C. Electric Utility Regulation

The law is perhaps no more obsessed with capital in any

other area than it is in the area of regulated electric utilities.

Regulated electric utilities are only permitted by their regulators

to charge ratepayers in accordance with the general formula

R = O + B• r

where R is the total allowed revenues (to be divided up

among ratepayers), O is the allowed operating expenses, B is the

company’s “rate base,” all those capital assets from which the

company is permitted to earn a return, and r is the permitted

rate of return.178 Given this regulatory structure, it is in the

company’s interest to acquire more capital and expand the rate

base as much as possible in order to maximize their permitted

revenues. This bias is commonly known as the “Averch–Johnson

effect.”179 Although additions to the company’s rate base must be

175. Id. at 119.

176. See id. at 125 (“[F]low-through shares raised a substantial amount of equity-based

financing for exploration and development[,] . . . were the dominant means by which funding

was raised for mining exploration[,] resulted in significant incremental spending on mining

and petroleum exploration and significant incremental exploration drilling activity[,] . . . and

assisted non-taxpaying junior exploration companies.”).

177. See MINING, MINERALS & SUSTAINABLE DEV. PROJECT, INT’L INST. FOR ENV’T & DEV.,

BREAKING NEW GROUND 172 (2002), http://pubs.iied.org/pdfs/G00900.pdf (“Many of the world’s

richest countries have benefited greatly from minerals extraction. Australia, Canada, Finland,

Sweden, and the United States, for example, have all had extensive minerals industries and

used them as a platform for broad-based industrial development.”).

178. FRED BOSSELMAN, JIM ROSSI & JACQUELINE LANG WEAVER, ENERGY, ECONOMICS,

AND THE ENVIRONMENT 507 (2000) (describing the formula).

179. Harvey Averch & Leland L. Johnson, Behavior of the Firm Under Regulatory

Constraint, 52 AM. ECON. REV. 1052, 1052–53 (1962).



“prudently incurred,”180 and must be “used and useful,”181 the

reality is that the company often has the upper hand in a

ratemaking setting in which it seeks to justify its expenditures to

a regulator.182 Empirical evidence for the Averch–Johnson effect

is not unambiguous, but generally supportive.183

Courts and commissions hearing ratemaking cases do not,

however, seem overly concerned about the Averch–Johnson

effect. In In re Limerick Nuclear Generating Station, the

Pennsylvania Public Utility Commission addressed the question

of whether a project may be included in the utility’s rate base if

the project was prudent at the time of commencement but had

subsequently become unnecessary.184 The opinion, one of only a

few that actually considered and discussed the Averch–Johnson

180. Duquesne Light Co. v Barasch, 488 U.S. 299, 309 (1989) (“Under the prudent

investment rule, the utility is compensated for all prudent investments at their actual

cost when made (their “historical” cost), irrespective of whether individual investments

are deemed necessary or beneficial in hindsight.”); Fed. Power Comm’n v. Hope Natural

Gas Co., 320 U.S. 591, 600 (1944) (discussing the Natural Gas Act’s requirement that all

natural gas rates be just and reasonable); Pa. Pub. Util. Comm’n v. Phila. Elec. Co., 31

P.U.R.4th 15, 29 (Pa. P.U.C. 1978) (entering judgment against a utilities company

because of expenditures “which would not have been made had prudent management

been exercised”); Richard A. Posner, Natural Monopoly and Its Regulation, 21 STAN. L.

REV. 548, 592, 617 (1969) (describing the basic workings of the regulatory process).

181. Barasch, 488 U.S. at 303–04; Bill Clinton et al., FERC, State Regulators, and

Public Utilities: A Tilted Balance?, NAT. RESOURCES & ENV’T, Spring 1987, at 11, 11, 43

(describing the “used and useful” requirement).

182. For a discussion of the administrative law surrounding ratemaking cases, see

Jacqueline Lang Weaver, Can Energy Markets be Trusted? The Effect of the Rise and Fall

of Enron on Energy Markets, 4 HOUS. BUS. & TAX L.J. 1, 13, 15 (2004), and Jim Rossi, The

Political Economy of Energy and Its Implications for Climate Change Legislation, 84 TUL.

L. REV. 379, 383, 391, 393 (2009). In In re Limerick Nuclear Generating Station, the

Pennsylvania Utilities Commission, in evaluating expert testimony on a variety of

technical and economic matters, wrote:

In performing our analysis, we are cognizant of the fact that many of the

calculations and figures presented in the context of this proceeding are

somewhat speculative. Although no one can perfectly see the future, we are

convinced that those estimates represent more than educated guesswork on the

part of the witnesses.

In re Limerick Nuclear Generating Station, 48 P.U.R.4th 190, 192 (Pa. P.U.C. 1982);

see also Posner, supra note 180, at 617 (showing that, in practice, the regulatory

agencies do not have as much power over ratemaking as they do in theory).

183. See, e.g., Léon Courville, Regulation and Efficiency in the Electric Utility

Industry, 5 BELL J. ECON. & MGMT. SCI. 53, 70 (1974) (confirming the Averch–Johnson

proposition of inefficiency); H. Craig Peterson, An Empirical Test of Regulatory Effects, 6

BELL J. ECON. & MGMT. SCI. 111, 112, 119, 124 (1975) (providing empirical evidence to

support the Averch–Johnson proposition); Robert M. Spann, Rate of Return Regulation

and Efficiency in Production: An Empirical Test of the Averch–Johnson Thesis, 5 BELL J.

ECON. & MGMT. SCI. 38, 49–50 (1974) (demonstrating the soundness of the Averch–

Johnson proposition through a trans-log production function).

184. In re Limerick Nuclear Generating Station, 48 P.U.R.4th, at 200–01.



effect, minimized its import.185 The Commission’s glib dismissal

of the Averch–Johnson effect reveals the bias of ratemaking

bodies:

We could better spend our time focusing on whether undue and unnecessary financial constraints are leading us toward a future of insufficient electricity supply and the attendant problems of unnecessarily high electricity prices, unnecessarily high oil consumption, and reduced economic growth. These questions transcend the close-in arguments on [construction work in progress] that turn on relatively technical points of consumer discount rates and impacts on cost of capital.186

This treatment seems to acknowledge that the Averch–

Johnson effect is a valid theoretical consideration, but not of any

practical importance, at least relative to other considerations.

That is regrettable, and it highlights how disinclined

policymakers and lawmakers are to critically consider the true

usefulness of hard and familiar capital. Utility commissions, it

would seem, are still more concerned with low electricity prices

and are willing to allow the construction of more capital to

ensure them.187

Electric utility regulation also presents the most compelling

illustration of how an industry will fight to maintain a privileged

position: rent-preserving through resisting policy reform. The

catchphrase “stranded costs” was born in the wake of widespread

state efforts to deregulate electricity generation and liberalize

energy markets.188 Liberalization means loss of monopoly power,

and incumbent electricity generation firms in states trending

towards deregulation complained loudly about the costs of power

plants that had not yet been recouped from ratepayers.189

Estimates of the amount of money believed to be at stake in the

185. Id. at 211–12 (“Averch–Johnson phenomenon—This concept, developed in the

early 1960s, maintains that the utilities will invariably seek to overbuild their systems.

The financial disincentive of not allowing [construction work in progress] in the rate base

is seen as counteracting this tendency. . . . The Averch–Johnson phenomenon is no longer

applicable—Even if it did apply in the early 1960s, there is little current credibility to the

[Averch–Johnson] phenomenon given the current depressed financial condition of the

industry.”).

186. Id. at 212.

187. Severin Borenstein, The Trouble with Electricity Markets: Understanding

California’s Restructuring Disaster, J. ECON. PERSP., Winter 2002, at 191, 192, 195

(illustrating this concern and its effects on the state of California).

188. Id. at 191, 193–94.

189. Mark Armstrong & David E.M. Sappington, Regulation, Competition, and

Liberalization, 44 J. ECON. LITERATURE 325, 329–30 (2006); Timothy J. Brennan & James

Boyd, Stranded Costs, Takings, and the Law and Economics of Implicit Contracts, 11 J.

REG. ECON. 41, 42, 44–46, 50 (1997).



mid-1990s, the height of deregulation speculation, ranged from

$34 billion to $210 billion.190 As explained in this Article,191 the

expected stream of benefits could well be greater than the value

of the capital stock. The specter of deregulation, which would

have disadvantaged incumbent electricity generators, was

enough for the industry to embark upon a massive campaign for

compensation.192

The campaigns surrounding electricity deregulation are

complicated because electricity deregulation itself is complicated.

States have traditionally regulated vertically integrated utilities,

and as such, have had primary jurisdiction over electricity

generation, transmission, distribution, and marketing.193

However, not only does the Federal Energy Regulatory

Commission (FERC) regulate the interstate transmission of

electricity,194 but the federal government has from time to time

played a prominent role in setting electricity policy, such as when

Congress passed the 1978 Public Utility Regulatory Policies Act

(requiring utilities to buy power from cogeneration sources and

from renewable energy sources)195 and the 1992 Energy Policy

Act, amended in 2005 (which required FERC to order the opening

of interstate transmission lines to independent generators),196

and when FERC actually issued the order to unbundle electricity

services197 and open up interstate transmission lines under Order

888 (which also mandated other requirements of utilities and

190. Eric Hirst & Lester Baxter, How Stranded Will Electric Utilities Be?, PUB. UTIL.

FORT., Feb. 15, 1995, at 30, 31.

191. See supra Part III.B.

192. Reed W. Cearley & Daniel H. Cole, Stranded Benefits Versus Stranded Costs in

Utility Deregulation, in 7 THE ECONOMICS OF LEGAL RELATIONSHIPS: THE END OF A

NATURAL MONOPOLY: DEREGULATION AND COMPETITION IN THE ELECTRIC POWER

INDUSTRY 169, 170–72, 179, 181–82, 184–85 (Peter Z. Grossman & Daniel H. Cole eds.,

2003).

193. Robert J. Michaels, Electricity and Its Regulation, LIBRARY ECON. & LIBERTY

(2008), http://www.econlib.org/library/Enc/ElectricityandItsRegulation.html.

194. What FERC Does, FED. ENERGY REGULATORY COMM’N,

https://www.ferc.gov/about/ferc-does.asp (last updated May 28, 2013).

195. Public Utility Regulatory Policies Act of 1978, Pub. L. No. 95-617, § 210, 92 Stat.

3117, 3144 (codified as amended at 16 U.S.C. § 824a-3 (2012)).

196. Energy Policy Act of 1992, Pub. L. No. 102-486, §§ 721–722, 106 Stat. 2776,

2915–20 (codified as amended at 16 U.S.C. §§ 824j–824k); Bob Eleff, Federal Regulation of

Electric Transmission: From Monopolistic Barrier to Competitive Force, RESEARCH DEP’T,

MINN. HOUSE OF REPRESENTATIVES 5 (Dec. 2012), available at http://www.house.leg.state.

mn.us/hrd/pubs/regelectric.pdf.

197. “Unbundling” means to break up the traditionally vertically integrated electric

utilities typical of the regulated monopoly regime. See, e.g., Paul L. Joskow, California’s

Electricity Crisis, 17 OXFORD REV. ECON. POL’Y 365, 367 (2001) (distinguishing between

“wholesale” and “unbundled” transmission service).



transmission owners).198 Lobbying and lawsuits thus took place

on both the state and federal levels.

The unusual characteristic of the electricity deregulation

debate was that almost all of the parties, from integrated electric

utilities, to consumer groups, to rural electric cooperatives,

agreed: electricity deregulation could work, if done properly

(their way).199 The disagreement was which path would be taken.

Electric utilities spent $5.4 million in 1992 campaign

contributions, which increased to $9.5 million in 1996.200 Interest

groups self-reported a conservatively estimated total of

$50 million in contributions.201 The end result is a mixed bag:

fifteen states, plus Washington, D.C., either fully deregulated or

actively regulated their electricity markets, and seven have

suspended their deregulation plans,202 including California,

which suffered the most humiliating failures of deregulation.203

As of 2010, the remaining states were not in the process of

deregulating electricity at all.204

Granted, electricity deregulation is complicated business,

challenging the capacity of elected legislatures to comprehend.

But given the consensus among interest groups that electricity

deregulation is a good thing (as long as they get their way), the

stalled nature of electricity deregulation serves as a testament to

the power of incumbency. If there is any doubt as to the power of

the electricity generation industry to get its way, more evidence

can be found in the American Clean Energy and Security Act of

2009, also known as Waxman–Markey after its House

sponsors.205 Waxman–Markey, which passed the U.S. House of

Representatives in 2009, would have instituted a greenhouse gas

198. 18 C.F.R. § 35.28 (2013).

199. Electricity Deregulation, OPENSECRETS, http://www.opensecrets.org/news/issues/

electricity/index.php (last visited Feb. 6, 2014).

200. Id.

201. Id.

202. U.S. ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY, STATUS OF ELECTRICITY

RESTRUCTURING BY STATE (Sept. 2010), available at http://www.eia.gov/cneaf/electricity/

page/restructuring/restructure_elect.html.

203. California electricity consumers suffered high prices and brownouts when

electricity suppliers accumulated market power through failures of the deregulation plan

and chose to withhold power in times of electricity shortages. See, e.g, Joskow, supra note

197, at 377–78, 384; Peter Navarro, On the Political Economy of Electricity Deregulation—

California Style, ELECTRICITY J., March 2004, at 47, 47–49, 53 (commenting on the

“California electricity crisis” and the mistakes leading up to it).

204. U.S. ENERGY INFO. ADMIN., supra note 202.

205. American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong.

(2009); HSU, supra note 7, at 120 (discussing how the Waxman-Markey Act “provided the

disadvantaged coal industries and the utilities that burn coal with enormous payoffs in

the form of free allowances”).



cap-and-trade program, allocating permits to emit greenhouse

gases, at least initially, by simply writing the allocations into the

bill.206 The largest recipient of freely allocated emissions permits?

Electric utilities would have received 43.75% of the freely

allocated allowances for 2012 and 2013, declining gradually to

7% by 2029.207 It was no surprise that the bill had the support of

the Edison Electric Institute, the trade association for electric

utilities, because it was deeply involved in writing it.208

D. Grandfathering

Grandfathering, or more generally “transition relief,” is a

common practice in lawmaking, especially in environmental

lawmaking.209 Because environmental regulation can severely affect

the value of capital, environmental laws have often exempted

existing capital from new laws or regulations.210 Lawmakers seem

particularly worried about negative impacts on capital.211

The normative discussion on grandfathering has been

largely efficiency-oriented, centering on a discussion of how to

206. American Clean Energy and Security Act of 2009, § 727.

207. Id. § 782(a).

208. EEI president Thomas Kuhn also made a number of post-passage efforts to

support a Senate bill that would be compatible with the Waxman–Markey bill he helped

craft. HSU, supra note 7, at 120 (illustrating the Edison Electric Institute’s partnership in

crafting the bill); John M. Broder, Senate Gets a Climate and Energy Bill, Modified by a

Gulf Spill That Still Grows, N.Y. TIMES, May 13, 2010, at A18 (“The leader of the main

utility industry trade group, Thomas R. Kuhn of the Edison Electric Institute, stood with

Mr. Kerry and Mr. Lieberman on Wednesday and endorsed their bill.”).

209. Bruce R. Huber, Transition Policy in Environmental Law, 35 HARV. ENVTL. L.

REV. 91, 92, 96 (2011) (noting that the distinction between new sources of pollution and

existing sources “reflects a recurring political problem faced by makers of environmental

policy”); Jonathan Remy Nash, Allocation and Uncertainty: Strategic Responses to

Environmental Grandfathering, 36 ECOLOGY L.Q. 809, 811 (2009) (“[T]he government

may choose to base allocations not on current activities, but on recent activities that

predate the announced intention to implement limitations on resource access. Such

systems have become increasingly common in the context of environmental and natural

resource regulation.”); Jonathan Remy Nash & Richard L. Revesz, Grandfathering and

Environmental Regulation: The Law and Economics of New Source Review, 101 NW. U. L.

REV. 1677, 1680 (2007) (“The problem of whether and how to extend favorable treatment

to existing sources is a recurring one in environmental law.”); Robert N. Stavins, Vintage-

Differentiated Environmental Regulation, 25 STAN. ENVTL. L.J. 29, 34 (2006)

(“[G]randfathering is likely to be a politically expedient option for legislators, since it

allows leeway in rewarding firms and in distributing the costs and benefits of regulation

among jurisdictions.”).

210. See Robertson, supra note 81, at 152, 157–58 (noting that environmental laws

often contain grandfathering clauses which exempt existing capital from new

regulations).

211. See, e.g., Huber, supra note 209, at 127 (“Both state and federal lawmakers have

shied away from imposing the enormous costs associated with the mandatory retrofit,

upgrade, or retirement of in-use diesel trucks . . . .”).



allocate the “costs of legal transitions.”212 Louis Kaplow’s seminal

An Economic Analysis of Legal Transitions argued against

grandfathering on the grounds that legal transitions are not

sufficiently different from other changes in the economic

environment to warrant different treatment.213 One might argue

that in legal changes, as in market changes, it is the private

party that is better able to anticipate change.214 The more

compelling arguments, however, point out how a regime of

grandfathering creates perverse incentives.215 There is obviously

the transition relief itself, which could become the subject of rent-

seeking.216 Also, regulatory targets might, in anticipation of

transition relief, have less incentive to anticipate very

foreseeable legal changes, for example, as a result of emerging

public health or safety concerns.217 Additionally, in regimes in

which transition relief might be pegged to historical baselines,

just a whiff of new regulation may send regulatory targets off in

a race to boost their baselines in the hopes of securing a larger

share of the impending transition relief.218 And finally,

policymakers have utterly failed to appreciate that grandfather

status confers an asset in the form of a legal exemption, which

competitors, but not incumbents, have to observe.219 This can be

an enormous advantage, and a barrier to entry, as new entrants

are required to spend hundreds of millions that incumbents do

212. See id. at 92 (suggesting that economists believe the crux of transition policy is

efficiency); see also DANIEL SHAVIRO, WHEN RULES CHANGE: AN ECONOMIC AND POLITICAL

ANALYSIS OF TRANSITION RELIEF AND RETROACTIVITY 221–23 (2000) (positing that delay is

superior to grandfathering for transition relief); Louis Kaplow, An Economic Analysis of

Legal Transitions, 99 HARV. L. REV. 509, 512, 584–87 (1986) (analyzing the undesirability

of grandfathering).

213. Kaplow, supra note 212, at 513, 581–82 (1986) (“As an initial hypothesis,

government transitions warrant the same treatment as market transitions: no transition

relief.”).

214. See Saul Levmore, Changes, Anticipations, and Reparations, 99 COLUM. L. REV.

1657, 1662–65 (1999) (explaining the incentive private parties have to anticipate changes

in the law).

215. See Maria Damon et al., Grandfathering 8, 10 (Ind. Univ. Sch. Pub. & Envtl.

Affairs, Research Paper No. 2012-11-03, 2012), available at http://ssrn.com/

abstract=2182573 (commenting on how grandfathering can “reduce economic efficiency

and social welfare”).

216. Levmore, supra note 214, at 1681–82, 1698.

217. Nash & Revesz, supra note 209, at 1725.

218. See Nash, supra note 209, at 820, 822, 836–37 (discussing the negative impact

that “first possession” can have on resources); see also Shi-Ling Hsu & James E. Wilen,

Ecosystem Management and the 1996 Sustainable Fisheries Act, 24 ECOLOGY L.Q. 799,

806–10 (1997) (describing how the fishing industry has responded to and evaded tight

regulations).

219. Steven Shavell, On Optimal Legal Change, Past Behavior, and Grandfathering,

37 J. LEGAL STUD. 37, 71, 73–75 (2008) (illustrating how grandfather status allows for

noncompliance with the regulation).



not.220 This has the ironic effect of slowing capital turnover

because abandoning the capital also means abandoning the

valuable asset (grandfather status), thereby delaying the

achievement of air quality benefits.221

A number of arguments have been offered in favor of

transition relief, but none are as general as the arguments

against it. Expensive, iterative technologically-based pollution

control mandates may warrant some transition relief.222 But the

context in which transition relief is discussed is not often of such

a clumsy command-and-control sort.223 It could also be that

awarding transition relief is a second-best outcome, inferior to a

policy change unaccompanied by transition relief, but better than

the status quo.224 But government’s inability to ascertain the

private costs and call a bluff is an invitation to rent-seeking that

may swamp any potential private palliative benefits.225 Finally, it

has been argued that regulatory bodies, not capital investors, are

in a better position to anticipate new regulation.226 But to the

extent that new regulation is meant to address changing market

conditions and emergent harms of some product or process, it

would seem to be capital investors, not regulatory bodies, that

are likely to have superior information.227 It is their capital, after

all, and in the first instance it would be capital investors

undertaking the due diligence of vetting the soundness of their

220. See Robertson, supra note 81, at 160–61, 167–69.

221. See, e.g., Hsu, supra note 81, at 10,096 (discussing grandfathering’s drag on

capital turnover); John A. List, Daniel L. Millimet & W. Warren McHone, The Unintended

Disincentive in the Clean Air Act, 4 ADVANCES ECON. ANALYSIS & POL’Y, no. 2, 2004, at 1,

13–14 (finding “deleterious effects on plant-level modification decisions”); Randy A.

Nelson, Tom Tietenberg & Michael R. Donihue, Differential Environmental Regulation:

Effects on Electric Utility Capital Turnover and Emissions, 75 REV. ECON. & STAT. 368,

369, 371, 373 (1993).

222. See Shavell, supra note 219, at 71–73 (discussing benefits and concerns of

grandfathering as transition relief).

223. See Cass R. Sunstein, Administrative Substance, 1991 DUKE L.J. 607, 627, 638–

39, 641, 645 (suggesting that command-and-control regulation is responsible in large part

for regulatory failure in the United States); Cass R. Sunstein, Congress, Constitutional

Moments, and the Cost-Benefit State, 48 STAN. L. REV. 247, 273, 297–300 (1996)

(reasoning that command-and-control regulation can often be dysfunctional).

224. See Levmore, supra note 214, at 1665–66 (suggesting that to achieve policy

change, a norm must be developed); Jonathan S. Masur & Jonathan Remy Nash, The

Institutional Dynamics of Transition Relief, 85 N.Y.U. L. REV. 391, 400–01 (2010)

(explaining under what conditions transition relief may be superior to the status quo).

225. See Levmore, supra note 214, at 1666–68 (sharing a pessimistic view of

transition relief).

226. See, e.g., W. Kip Viscusi, The Dangers of Unbounded Commitments to Regulate

Risk, in RISKS, COSTS, AND LIVES SAVED 135, 137, 139 (Robert W. Hahn ed., 1996)

(demonstrating why regulatory bodies are better inclined to anticipate changes).

227. Levmore, supra note 214, at 1657, 1659 & n.5, 1675, 1680.



investment. For example, there is no reason to believe that the

Environmental Protection Agency would have any advantage in

anticipating the environmental risks of hydraulic fracturing than

the oil and gas companies that engage in it.

But all of these arguments speak to behavior after the

formation of capital. The less obvious but possibly greater

distortion is the ex ante effect that an expectation of

grandfathering has on capital investment decisions. A

substantial part of the risk of new capital is the risk of

premature obsolescence due to regulatory action, the emergence

of superior alternatives, or some other unexpected shock.228

Absent risk, there is no reason that investors would abstain from

supersizing their capital investments. Insuring, even partially,

against the risk of obsolescence by regulation biases investors

towards larger capital investments. And all other things being

equal, larger capital investments will inspire larger efforts to

defend them.229

It is thus not so much that grandfathering inhibits policy

change because it delays compliance with updated standards of

behavior (a common complaint from environmentalists);230 it is

that grandfathering inhibits policy change because it emboldens

capital investors. Armed with the knowledge that legislatures

and agencies will only reluctantly impose new costs, capital

investors will, from a societal point of view, overinvest. Moreover,

the more expensive the capital, the more reluctant lawmakers

will be to regulate it.231

So common is the provision of at least some transition

relief232 that regulatory targets cannot help but notice and feel at

228. See David Gabel, Divestiture, Spin-Offs, and Technological Change in the

Telecommunications Industry—A Property Rights Analysis, 3 HARV. J.L. & TECH. 75, 95–

96 (1990) (discussing premature obsolescence in the telecommunications industry).

229. See supra note 96 and accompanying text (discussing the rationale of investing,

absent risk).

230. See, e.g., NRDC: Regulating Obesogens, ONEARTH (June 27, 2011),

http://www.onearth.org/article/nrdc-regulating-obesogens (“When TSCA was first passed,

over 60,000 chemicals were ‘grandfathered’ in, with no requirement for toxicity

information to continue their production. . . . While rates of diseases linked to chemical

exposures continue to rise, the federal system that is supposed to be protecting us is

unable to do the job and millions of people are at risk.”); see also Natural Res. Def. Council

v. Thomas, 838 F.2d 1224, 1243 (D.C. Cir. 1988) (“NRDC attacks several elements of the

grandfathering as too generous . . . .”).

231. See Huber, supra note 209, at 127 (describing how “direct and indirect

compliance costs associated with regulatory objectives affect their structure and

implementation”).

232. See Damon et al., supra note 215, at 4–5 (commenting on how grandfather

clauses serve as exemptions from regulatory requirements and may or may not be limited

to a certain period of time).



least partially insured against changes in legal rules that might

jeopardize their capital.233 The provision of transition relief has

been elevated to almost norm status.234 Capital investors have

come to expect a right to extract some profits out of their capital,

regardless of its inherent usefulness, and regardless of the social

harms it will impose, foreseeable or not. Transition relief, based

on a misguided intuition, has made the obsolescence of capital

everybody’s problem. Everybody, that is, except the owners of

obsolescent capital.

E. Regulatory Takings Jurisprudence

If there were a legal development that would exemplify the

misguided bias in favor of capital, it would be the rise in

regulatory takings jurisprudence. For approximately the last

thirty-five years, the Supreme Court has been extremely

interested in scrutinizing land use regulations to see if they are

so onerous as to constitute a regulatory taking of property

triggering a Fifth Amendment requirement of compensation.235

The effects of this doctrinal lurch toward property rights

protection are not obvious. But more than any other legal or

policy phenomenon, it reveals the one-sidedness with which laws

and legal institutions (most prominently the Supreme Court)

have come to view capital.

Justice Brennan’s three-factor analysis in Penn Central

Transportation Co. v. New York City,236 still the default test for

what constitutes a regulatory taking requiring the payment of

compensation,237 prominently includes consideration of “the

extent to which the regulation has interfered with distinct

233. See Nash & Revesz, supra note 209, at 1726 (“[W]hen the government enacts a

new legal regime with transition relief, it sends a signal to society at large that, in

general, changes in legal standards will not govern existing actors.”).

234. See Huber, supra note 209, at 98, 112 (“[F]ull grandfathering is the norm in

land use regulation.”); Kyle D. Logue, Legal Transitions, Rational Expectations, and Legal

Progress, 13 J. CONTEMP. LEGAL ISSUES 211, 215 (2003) (noting the “legislative norm of

applying legislative changes nominally prospectively”).

235. See Joseph L. Sax, Land Use Regulation: Time to Think About Fairness, 50 NAT.

RESOURCES J. 455, 457 (2010) (“[D]uring the FDR era, the Court became more

sympathetic to regulation, only to shift again starting around 1980. In recent decades, the

more conservative majority on the Supreme Court has shown that the Court is, again,

quite sympathetic to the constitutional claims of property owners.”).

236. Penn Cent. Transp. Co. v. New York City, 438 U.S. 104, 124 (1978). The three

factors are: the character of the government action, the economic impact upon the

claimant, and the interference with investment-backed expectations. Id.

237. Lingle v. Chevron U.S.A. Inc., 544 U.S. 528, 538 (2005) (“[R]egulatory takings

challenges are governed by the standards set forth in [Penn Central].”); see also Koontz v.

St. Johns River Water Mgmt. Dist., 133 S. Ct. 2586, 2604 (2013) (Kagan, J., dissenting).



investment-backed expectations.”238 Although the jurisprudence

and the literature do not explicitly say so, investment-backed

expectation interests are what judges think are the interests in a

stream of benefits stemming from the exploitation of capital. In

the numerous regulatory takings cases that followed Penn

Central, it is obvious the extent to which courts have paid careful

attention to what owners of capital expect.239 It is less obvious

that courts seem to have lost sight of the social welfare of

regulation attacked by regulatory takings litigation.

In Lucas v. South Carolina Coastal Council, perhaps the

most prominent beachhead for property rights advocates, the

Court squarely focused itself on the impacts on the petitioning

landowner, finding that a South Carolina statute, in blocking

development of a residential lot on a barrier island otherwise

crowded with houses, effectively deprived a land developer of

“economically viable use of the land.”240 Justice Scalia’s majority

opinion stated that,

[A]t the time Lucas acquired these parcels, he was not legally obliged to obtain a permit from the Council in advance of any development activity. His intention with respect to the lots was to do what the owners of the immediately adjacent parcels had already done: erect single-family residences. He commissioned architectural drawings for this purpose.241

Quite explicitly, Justice Scalia’s opinion, as do the vast

majority of regulatory takings cases, places the regulatory

takings focus on the effects of regulation on the landowner.242

Very little is said anymore about the common law police power

that has served as the general regulatory authority for state and

local governments for decades.243

238. Penn Cent. Transp. Co., 438 U.S. at 124.

239. See, e.g., Tahoe-Sierra Pres. Council, Inc. v. Tahoe Reg’l Planning Comm’n, 535

U.S. 302, 352 (2002) (Rehnquist, J., dissenting) (noting the extent to which the duration of

a moratorium interferes with the economically beneficial use of the land); Palazzolo v.

Rhode Island, 533 U.S. 606, 626–27 (2001) (finding that regulations existing at the time of

purchase are not the sole determiner of investment-backed expectations and can be

challenged); E. Enters. v. Apfel, 524 U.S. 498, 532 (1998) (holding that a requirement to

make retroactive contributions to a fund for coal mine workers suffering from black lung

disease frustrated petitioner’s investment-backed expectations).

240. Lucas v. S.C. Coastal Council, 505 U.S. 1003, 1006–09, 1016, 1031–32 (1992).

241. Id. at 1008 (emphasis added).

242. See id. at 1008–09, 1027–31 (highlighting how the Beachfront Management Act

disturbed the petitioner’s property rights); see also Tahoe-Sierra Pres. Council, Inc., 535

U.S. at 306, 320–24; Penn Cent. Transp. Co., 438 U.S. at 124–25, 136–38.

243. D. Benjamin Barros, The Police Power and the Takings Clause, 58 U. MIAMI L.

REV. 471, 472 (2004) (“The term ‘police power’ . . . has been ignored in contemporary

takings jurisprudence.”).



In Rose Acre Farms, Inc. v. United States, one of the largest

egg producers in the United States challenged an emergency

order by the U.S. Department of Agriculture to slaughter all of

the chickens in three of Rose Acre’s large chicken egg farms and

to clean and sanitize the hen houses, following a series of

salmonella outbreaks that were all traced to the three farms.244

Rose Acre was still allowed to sell the eggs in liquid form.245 Rose

Acre still sued, claiming that its diminished profits constituted a

regulatory taking.246 Astonishingly, the Court of Federal Claims

agreed, ruling that the emergency health order did in fact

unconstitutionally take Rose Acre’s property, awarding Rose Acre

over $6 million in damages.247 Applying the Penn Central test,

the court held that the order interfered with Rose Acre’s

investment-backed expectations,248 that the economic impact

upon Rose Acre was severe,249 and that the character of the

government action impermissibly favored the government.250 On

appeal, the Court of Appeals for the Federal Circuit reversed, but

left intact the lower court’s application of the investment-backed

expectations part of the test.251 Even as the court cautiously

upheld an emergency public health measure to prevent the

recurrence of a harm traceable to the petitioner’s farms that had

already sickened hundreds of people,252 the court let stand the

hopelessly one-sided part of the lower court’s opinion regarding

the effect on petitioner’s capital.253

One could argue (many have) that property law in particular

has gotten carried away with thinking about rights and

neglecting correlative duties.254 The Supreme Court has certainly

244. Rose Acre Farms, Inc. v. United States, 55 Fed. Cl. 643, 646–52 (2003), rev’d,

559 F.3d 1260 (Fed. Cir. 2009), cert. denied, 559 U.S. 935 (2010).

245. Id. at 647 & n.1, 648.

246. Id. at 653.

247. Id. at 670.

248. Id. at 659.

249. Id. at 658.

250. Id. at 659–60.

251. Rose Acre Farms, Inc. v. United States, 559 F.3d 1260, 1265–66, 1275–76,

1283–84 (Fed. Cir. 2009).

252. Id. at 1262–64; Brief for the United States in Opposition at 2, Rose Acre Farms,

Inc. v. United States, 559 U.S. 935 (2010) (No. 09-342) (reporting 3,300 cases of

salmonella during a 1986 outbreak).

253. Rose Acre Farms, Inc., 559 F.3d at 1265–66, 1283.

254. See Joseph William Singer, The Ownership Society and the Takings of Property:

Castles, Investments, and Just Obligations, 30 HARV. ENVTL. L. REV. 309, 313–14 (2006)

(suggesting an alternative model of property that “starts from the idea that owners have

obligations as well as rights”); Laura S. Underkuffler, Tahoe’s Requiem: The Death of the

Scalian View of Property and Justice, 21 CONST. COMMENT. 727, 729, 731–32, 752 (2004)

(discussing how “property claims are so often . . . unavoidably reciprocal in character” and



done its part to tilt the inquiry in that direction. When the Court

has addressed the harm-prevention goals of a land use

restriction, it has scrutinized the restrictions and their

effectiveness, taking a skeptical view of the assertions of the land

use regulatory agencies.255 It is striking that regulatory takings

law so consciously focuses on the welfare of capital, and not social

welfare. Courts have been willing to expand the regulatory

takings inquiry into a number of areas beyond land use

regulation, including water,256 offshore oil leasing,257

governmental contractual rights,258 and intellectual property.259

Electric utilities, facing losses due to new competition arising

from deregulation260 have even raised regulatory takings claims

from de-regulation.261 At bottom, regulatory takings law has

sought to protect the expectation interests of owners of capital.262

This deference to capital owners on the one hand, and skepticism

towards the regulator and the social harm on the other, is

analogous to the one-sidedness with which we view the benefits

and the costs of capital. The law, as we do, only seems to

cause courts to arbitrarily balance “reciprocal evils[] done by reciprocal actors” (internal

quotation marks omitted)).

255. In Lucas, Justice Scalia, critical of Justice Blackmun’s reliance on the common

law police power to permit harm-preventing land use restrictions, writes that

In Justice Blackmun’s view, even with respect to regulations that deprive an

owner of all developmental or economically beneficial land uses, the test for

required compensation is whether the legislature has recited a harm-preventing

justification for its action. Since such a justification can be formulated in

practically every case, this amounts to a test of whether the legislature has a

stupid staff.

Lucas v. S.C. Coastal Council, 505 U.S. 1003, 1025 n.12 (1992) (emphasis added) (citation

omitted).

256. Klamath Irrigation Dist. v. United States, 635 F.3d 505, 508–09, 519, 521–22

(Fed. Cir. 2011) (holding that a reduction in a water allocation under a state statute could

be a regulatory taking if the allocation was reduced to fulfill trust obligations to Native

Americans and to comply with the Endangered Species Act); Tulare Lake Basin Water

Storage Dist. v. United States, 49 Fed. Cl. 313, 313–14, 319 (2001) (holding that reducing

water deliveries to comply with the Endangered Species Act was a physical taking).

257. Union Oil Co. of Cal. v. Morton, 512 F.2d 743, 746, 751 (9th Cir. 1975) (holding

that the suspension of offshore oil drilling operations after a 1969 oil spill off the southern

California coast, pending an environmental review, was a taking).

258. Stockton E. Water Dist. v. United States, 583 F.3d 1344, 1369 (Fed. Cir. 2009)

(holding that a water contract right-holder could assert a regulatory takings claim for

breach).

259. Philip Morris, Inc. v. Reilly, 312 F.3d 24, 45–46 (1st Cir. 2002) (holding that

intellectual property rights can be rights that can be the subject of a regulatory taking).

260. See supra Part IV.C (discussing the financial effect of deregulation on

incumbent electricity generation firms).

261. Susan Rose-Ackerman & Jim Rossi, Disentangling Deregulatory Takings, 86 VA.

L. REV. 1435, 1457 (2000) (explaining that utilities companies have made takings claims

due to so-called “stranded costs” resulting from deregulation).

262. See supra note 239 and accompanying text.



appreciate the benefits of capital formation, and not so much the

costs.

All that said, a consensus seems to exist that the changes in

regulatory takings law have been modest.263 Regulatory takings

jurisprudence over the last thirty years has not remade the legal

landscape for land use regulation or for regulation generally.264

Regulatory takings law is not exhibit A for this Article’s thesis

that capital-friendly law has created an overcapitalized economy.

Rather, what the last three decades of regulatory takings law

seem to show is how legal thinking reflects a desire to protect

capital to the detriment of less tangible, more diffuse but

potentially much more important social, economic,

environmental, and public health interests. Moreover, Justices

Scalia, Thomas, Roberts, and Alito, the four justices most

inclined to uphold private property rights against governmental

interference, may not be done.265 Regulatory takings

jurisprudence may still yet solidify a legal bias for entrenching

capital.

F. The Politics of Human and Social Capital

All of these laws and regulations confer some preferential, or

at least special status on physical capital. But what about social

and human capital? It is less obvious, but potentially more

important, that law, regulations, government policy, and even

private firms have inclinations to protect human and social

capital. While laws do not explicitly or structurally favor human

or social capital the way they privilege physical capital, it is clear

that political institutions bias decisions towards preserving

human and social capital.266 The pervasiveness of grandfathering

is one example. Behind the desire to preserve physical capital lies

the connected desire to preserve the jobs, know-how, and social

networks that derive from operation of physical capital.

263. See, e.g., Sax, supra note 235, at 467 (arguing that the Supreme Court’s

regulatory takings jurisprudence is undeveloped and unhelpful as applied to general

issues of unfairness).

264. See id. at 458 (noting that since the 1980s, the Supreme Court “has failed to

provide clear guidance in regulatory takings cases”).

265. See, e.g., Garrett Power, Property Rights, the “Gang of Four” & the Fifth Vote:

Stop the Beach Renourishment, Inc. v. Florida Department of Environmental Protection

(U.S. Supreme Court 2010), 21 WIDENER L.J. 627, 634, 644–45 (2012) (arguing that the

four justices inclined to uphold property rights are still casting for a fifth vote to overrule

Penn Central).

266. See, e.g., GOLDIN & KATZ, supra note 56, at 198 (discussing how state laws that

governed school districts’ fiscal responsibilities played a prominent role in increasing

enrollment in schools by providing poorer school districts with grants to build schools and

supplement teacher salaries).



Unlike physical capital, human and social capital are most

ardently supported in the legislative branch. For communities,

businesses, and industries that are heavily dependent upon their

human and social capital, and for whom alternative existences

seem remote and implausible, reform represents an existential

threat to the owners of that capital. Elections in coal mining

communities, for example, become single-issue elections, with

coal jobs taking center stage.267 In the 2012 election cycle,

campaigns in coal country states such as Virginia, Kentucky, and

Pennsylvania focused heavily on coal, drawing a number of

Democrats into the coal camp.268 In West Virginia, where

President Obama is viscerally hated for his perceived hostility to

coal,269 the President was outpolled in several large counties in

the state’s Democratic primary by a convicted felon, still

incarcerated in Texas.270

Fortunately for coal-mining communities in West Virginia,

they had the luck of being represented by former Senate majority

leader Robert Byrd.271 In a five-decade-long career in the Senate,

Byrd regularly championed coal-mining communities, regularly

foiling air pollution regulation efforts:

267. See, e.g., Bruce Schreiner, Grimes Defends Coal, Touts Jobs Plan for Kentucky,

MIAMI HERALD (Jan. 16, 2014), available at www.miamiherald.com/2014/01/16/3875793/

grimes-defends-coal-touts-jobs.html (“Coal mining, a major industry in Kentucky, has

emerged as a central issue in the Senate race.”); Jennifer Yachnin, Republicans Talk Up

Coal, Keystone XL as Economic Themes Take Center Stage, GREENWIRE (Aug. 29, 2012),

http://www.eenews.net/greenwire/stories/1059969329/print (“Republican candidate Andy

Barr [argued that] [t]his year alone, 2,000 Kentucky miners lost their jobs because of

overregulation and Obama’s war on coal. For every mining job lost, three additional jobs

are threatened.” (internal quotation marks omitted)).

268. Roger Alford, Chandler, Barr Spar Over Economy, Jobs, ST. J. (Oct. 30, 2012),

available at http://www.state-journal.com/local%20news/2012/10/30/chandler-barr-spar-

over-economy-jobs (noting coal’s importance to Kentucky candidates in the 2012 U.S.

Senate race); Josh Kurtz, 2 Democrats in Close Races Profess Strong Support for Coal in

New TV Ads, E&E NEWS PM (Sept. 13, 2012), http://www.eenews.net/eenewspm/

stories/1059969935/print (“In Virginia, former Gov. Tim Kaine (D), who is locked in a

tight open-seat race against former Sen. George Allen (R), launched an ad today in which

he touts the help his administration gave a coal plant in southwest Virginia when he was

governor. . . . ‘This state-of-the-art coal plant in southwest Virginia, where my wife’s from,

created 2,500 new jobs,’ Kaine says. . . . Meanwhile, in Pennsylvania’s 12th

District . . . Rep. Mark Critz (D) began airing an ad . . . that blisters the Obama

administration for its environmental regulations. ‘Seven hundred coal jobs depended on

building an air shaft at the Cumberland Mine,’ Critz says . . . ‘[b]ut we had to fight

President Obama’s EPA to get it built.’”).

269. Manuel Quinones, Appalachia Fights Back Against President’s Coal Policies,

ENV’T & ENERGY DAILY (May 10, 2012), http://www.eenews.net/stories/1059964186/print

(referencing Obama’s low popularity ratings in West Virginia due to his “agenda to

tighten pollution controls”).

270. Id.

271. Adam Clymer, A Pillar of the Senate, a Champion for His State, N.Y. TIMES,

June 29, 2010, at A1.



Arguments have been made that costs and dislocations caused by the compliance requirements of this legislation pale in comparison to the public health benefits. But what will we really have accomplished if we succeed in removing certain pollutants from the air and at the same time level the economies of whole communities and regions? Is that progress? Is that kind of devastation not even to be considered here? . . . When mines are shut down, not only do miners and their families suffer but whole communities also suffer.272

What is it about coal mine workers and their communities that

make them so invested in a livelihood so fraught with danger and

disease?273 Granted, culture, identity, and personal pride are at

work. But part of the answer must also be that there is embedded

but unpriced capital in coal mining. This not only includes the

physical equipment for coal mining operations, but also potentially

more importantly, a tremendous amount of social and human

capital wrapped up in coal mining and its ancillary businesses.

By no means is coal mining special among resource

industries. Rural communities in many resource exploitation

industries have found political champions that have sought to

protect the social fabric around which their economic and

social lives are bound. Logging communities found an ally in

the late U.S. Senator Slade Gorton:

That preservation law has wreaked incomprehensible havoc on timber families who have had to live with prolonged uncertainty about their futures. All indices of human despair have gone through the roof in these communities: child abuse, spousal abuse, alcohol and substance abuse, divorce, adolescent depression and suicide attempts, bankruptcies, and illness. All of these have been exacerbated by the terrible and unintended consequences of the Endangered Species Act of 1973.274

272. 136 CONG. REC. 796–97 (1990) (statement of Sen. Robert Byrd).

273. DIV. OF RESPIRATORY DISEASE STUDIES, U.S. DEP’T OF HEALTH & HUMAN

SERVS., PUB. NO. 94-120, WORK-RELATED LUNG DISEASE SURVEILLANCE REPORT 30 tbl.3-1

(1994), available at http://www.cdc.gov/niosh/docs/94-120/pdfs/94-120.pdf (identifying coal

mining as occupation on death certificate in sixty-nine percent of pneumoconiosis-related

deaths between 1985 and 1990); NAT’L INST. FOR OCCUPATIONAL SAFETY & HEALTH, U.S.

DEP’T OF HEALTH & HUMAN SERVS., PUB. NO. 201-172, COAL MINE DUST EXPOSURES AND

ASSOCIATED HEALTH OUTCOMES: A REVIEW OF INFORMATION PUBLISHED SINCE 1995, at

19 figs.14–15 (2011), available at http://www.cdc.gov/niosh/docs/2011-172/pdfs/2011-

172.pdf (showing age-adjusted death rates, years of potential life lost before age sixty-five,

and mean years of potential life lost (per million) for decedents age twenty-five years or

older in the United States between 1968 and 2006 with coal workers’ pneumoconiosis as

the underlying cause of death).

274. 138 CONG. REC. 31,856 (1992) (statement of Sen. Slade Gorton).



And in the environmentally-minded state of Massachusetts,

the uniformly Democratic congressional delegation has

consistently and vigorously fought fishing limitations set by the

National Marine Fisheries Service under the Sustainable

Fisheries Act.275 Iconic liberal Congressman Barney Frank, who

held a ninety-two percent favorability rating from the League of

Conservation Voters when he retired in 2012,276 has often led the

charge. In a 2009 letter to National Oceanic and Atmospheric

Administration (NOAA) Administrator Jane Lubchenco, Frank

urged Dr. Lubchenco that the NOAA “must be willing to act on

its own to ensure decisive and immediate action to implement

revised regulations necessary to protect fishermen and fishing

communities from unnecessary and often devastating financial

hardship.”277 Several months later, after apparently receiving

little mollification from Lubchenco, Frank called for her

resignation, putatively over agency misconduct.278 Massachusetts

Attorney General Martha Coakley, in suing NOAA last year for

setting tight fishing limits, complained of a “callous disregard for

the well-being of New England fishermen,” that will lead to the

“extinction of an industry that for more than a century has been

a part of the commercial and social fabric of New England.”279

What these statements exemplify is a rhetorical focus on

jobs, families, and communities. In the vernacular of this Article,

they represent human capital and social capital, and in rural,

resource-based economies, they represent capital in groups where

capital is otherwise scarce. When human and social capital are

the only assets belonging to an individual or a group, a threat to

that capital sets up a particularly acute public choice problem—

the interests of capital owners are extremely and intensely

275. 16 U.S.C. §§ 1801–1884 (2012); Shawn Zeller, Fish Fight: The Massachusetts

Congressional Delegation Is Usually in Sync with Environmentalists, but Not on Fishing

Limits, COMMONWEALTH (Apr. 12, 2011), http://www.commonwealthmagazine.org/

Departments/Washington-Notebook/2011/Spring/Fish-fight.aspx (“[T]he Massachusetts

representatives insist that it’s they who are in the right, defending an ancient way of life

against rules that they believe will drive small fishermen out of business.”).

276. National Environmental Scorecard: Representative Barney Frank (D), LEAGUE

OF CONSERVATION VOTERS, http://scorecard.lcv.org/moc/barney-frank (last visited Feb. 11,

2014).

277. Letter from Barney Frank, Rep., U.S. House of Representatives, to Dr. Jane

Lubchenco, Adm’r, Nat’l Oceanic and Atmospheric Admin., U.S. Dep’t of Commerce (Oct.

26, 2009), available at http://www.savingseafood.org/images/documents/congress/10_26_

09_lubchenco_frank.pdf.

278. Matt Viser, Frank, Tierney Call on NOAA Chief’s Dismissal, BOS. GLOBE (July

8, 2010), http://www.boston.com/news/politics/politicalintelligence/2010/07/frank_calls_on.

html.

279. Petition for Judicial Review at 1–2, 6, Massachusetts v. Blank, 1-13-cv-11301

(D. Mass. 2013), available at http://www.mass.gov/ago/docs/press/2013/1-13-cv-11301.pdf.



concentrated, as opposed to those that would benefit from

environmental protection. This dependence on continued

exploitation of capital can generate psychological effects that defy

objective facts. Desperate owners of threatened capital will

zealously reject notions that their practices and their capital

have become harmful or anachronistic.280

V. WHITHER, CAPITAL? A REFOCUS ON PUBLIC GOODS

It is important to emphasize what this Article is not arguing.

This Article is not arguing that the formation of capital should

never be promoted or subsidized or that capital should never be

protected. Public goods,281 after all, are often capital goods, and

this Article is certainly not arguing that we should abandon

direct government provision or funding of national defense,

schools, parks, law enforcement, and a judiciary, all of which are

capital goods within the working definition set out in this

paper.282

The conceptual difficulty is that public goods are rarely “pure,”

in that they are perfectly nonexcludable and perfectly

nonrivalrous.283 The question for government provision or funding

of a given project then, is how “pure” of a public good is the project?

There are certainly capital goods that are not purely public goods

but may be quasi-public goods, and sufficiently possess public good

characteristics as to warrant subsidization. Network goods, such as

railroad lines, roads and highways, and ports all have at least some

degree of public funding, direct or indirect.284

280. See, e.g., Kimberly Morrison, Fishing Industry Fights Red Snapper Regulations,

JACKSONVILLE BUS. J., http://www.bizjournals.com/jacksonville/stories/2009/06/01/

story5.html (last updated May 28, 2009) (discussing a situation where fishermen strongly

opposed federal regulation of red snapper fishing even though an assessment showed the

snapper were being overfished at “nine times the sustainable level”).

281. Public goods are nonexcludable (meaning that once they are provided, people cannot

be excluded from enjoying them), and nonrivalous (meaning that consumption by one

individual does not detract from consumption by another). See ROBERT CAMERON MITCHELL &

RICHARD T. CARSON, USING SURVEYS TO VALUE PUBLIC GOODS: THE CONTINGENT VALUATION

METHOD 1 n.1 (1989); RICHARD CORNES & TODD SANDLER, THE THEORY OF EXTERNALITIES,

PUBLIC GOODS, AND CLUB GOODS 8–9 (2d ed. 1996).

282. See supra Part II (defining capital as “a long-lived asset that generates a stream of

benefits” (emphasis omitted)).

283. See MITCHELL & CARSON, supra note 281, at 1 n.1 (“Pure public goods are

characterized by the conditions of non-excludability of and non-rivalry congestion between

individuals who wish to use the good . . . . In the real world, few public goods meet these strict

conditions . . . .”).

284. See, e.g., HOUSE COMM. ON TRANSP. & INFRASTRUCTURE, IMPROVING THE

NATION’S FREIGHT TRANSPORTATION SYSTEM: FINDINGS AND RECOMMENDATIONS OF THE

SPECIAL PANEL ON 21ST CENTURY FREIGHT TRANSPORTATION 15, 31, 37 53 (2013)

(discussing federal funding programs for highways, harbors, airports, and railroads).



But one reason that legal institutions have gotten into the

bad habit of overpromoting capital is that some capital projects

have looked enough like public goods to warrant subsidization.

Certain capital projects hold the promise of conferring new

positive externalities so as to apparently justify government

funding or some other legal mechanism to promote its

development. So how can meritorious public good-like projects be

distinguished from the ordinary capital projects which require no

public support and are simply part of the overcapitalization

problem?

One type of misguided motivation for promoting capital is an

apparent desire for low commodity prices. Driving energy prices

down and keeping them low appears to have been a central part

of American industrial policy.285 An original justification for

subsidies was to stimulate capital investment in the oil and gas

industries, once considered undercapitalized and immature.286

Favorable tax rules incentivized exploration and production by

reducing capital costs and uncertainty,287 an effort that has been

spectacularly successful.288 Capital investment in these sectors is

considerably higher than private investment alone would have

achieved.289 But well past the point at which the oil and gas

industries in the United States could be considered immature,

and past the point at which firms were unable to diversify risks

of failure, the subsidies persisted.290 Once the old justifications

285. See Mona Hymel, The United States’ Experience with Energy-Based Tax

Incentives: The Evidence Supporting Tax Incentives for Renewable Energy, 38 LOY. U. CHI.

L.J. 43, 67 (2006); see also Reforming Energy Subsidies: Summary Note, IMF,

http://www.imf.org/external/np/fad/subsidies/pdf/note.pdf (last visited Feb. 6, 2014)

(explaining how subsidies are meant to maintain low prices for consumers); Yuki Noguchi,

Solyndra Highlights Long History of Energy Subsidies, NPR (Nov. 16, 2011),

http://www.npr.org/2011/11/16/142364037/solyndra-highlights-long-history-of-energy-

subsidies (describing the long history of subsidies, beginning in 1918, for the American oil

and gas industry).

286. Hymel, supra note 285, at 47.

287. Id.

288. See id. at 64–65 (“The federal government’s huge investment in the petroleum

industry . . . influenced how quickly and dramatically the United States developed into a

fossil fuel-driven society.”); Mead, supra note 110, at 352 (“[T]ax subsidies led to increased

capital flows into exploration . . . and production was stimulated. . . . [I]ncreased

production led to lower oil prices and established the historic U.S. low-price policy for

energy.”).

289. See Cox & Wright, supra note 110, at 188–89 (demonstrating how special tax

provisions have increased investment in petroleum reserves); Mead, supra note 110, at

352 (“[T]ax subsidies led to increased capital flows into exploration.”); supra text

accompanying notes 132–33 (discussing the staggering oil and gas subsidies that spurred

this capital investment).

290. Hymel, supra note 285, at 47–48 (stating that the tax subsidies persisted even

when it was clear that the nation’s increasing demand for oil showed no signs of slowing).



became implausible, new justifications emerged: (i) that national

security demanded an expansion of supply to reduce dependence

upon unstable foreign regimes,291 and (ii) the maintenance of low

consumer prices.292 Such ex post rationalization of continued

subsidies is a hallmark of an overcapitalized industry addicted to

government support.

Promoting the formation of capital to maintain low

commodity prices is mistaken thinking because low commodity

prices are not a public good.293 It is true that low energy prices

spur all kinds of economic activity that might not have occurred

without them.294 In that sense, capital producing low energy

prices produces substantial positive externalities. But as the last

half-century of energy development has demonstrated,

subsidizing fossil fuels is not the only way to produce low energy

prices. But because of huge amounts of entrenched capital in the

fossil fuel industries, change has been slow coming.295

This pattern of initial government subsidization, followed by

large capital inflows into a targeted sector, followed by a

stubborn resistance to subsidy reform, repeats itself in a number

of resource sectors. Agricultural subsidies in the United States

have not only distorted markets, but they also contributed to the

capital intensification of agriculture.296 Fisheries subsidies have

created a larger fleet of larger fishing boats, exacerbating an

overcapitalization problem and creating a persistent overfishing

problem.297 Unsurprisingly, reform in these and other capital-

291. Id. at 68, 70.

292. Id. at 47–48.

293. See supra note 281 (defining “public goods”).

294. See, e.g., Hymel, supra note 285, at 67 (illustrating how low energy prices often

encourage petroleum consumption rather than conservation); David M. Smolin, The

Paradox of the Future in Contemporary Energy Policy: A Human Rights Analysis, 40

CUMB. L. REV. 135, 172 (2009) (“Conventional energy policy seeks to facilitate an adequate

supply of energy at a low price in order to facilitate economic activity and growth.”).

295. Hymel, supra note 285, at 67 (discussing how increased profitability in the

petroleum industry “increased investments in petroleum exploration” but “inhibited the

development of alternatives to fossil fuels”); see also supra Part III.A.

296. SUZANNE IUDICELLO, MICHAEL WEBER & ROBERT WIELAND, FISH, MARKETS, AND

FISHERMEN: THE ECONOMICS OF OVERFISHING 60 (1999) (“[T]he key feature of subsidy

policies is that they distort the way markets operate . . . .”); William S. Eubanks II, A

Rotten System: Subsidizing Environmental Degradation and Poor Public Health with Our

Nation’s Tax Dollars, 28 STAN. ENVTL. L.J. 213, 214–15 (2009) (arguing that the United

States Farm Bill “encourages overproduction, trade distortion, and depression of world

market prices”).

297. IUDICELLO, WEBER & WIELAND, supra note 296, at 60–63 (explaining how

subsidies have led to overexploitation of marine life by encouraging the use of “technology

that increases the capacity to exploit natural resources” and creating “oversized fishing

fleets and . . . overfishing”).



heavy sectors has been virtually impossible.298 And worthy of

note, it has not necessarily been the absolute size of the costs of

government support that is of such great importance to the

capital-owning resource users; it is the relative importance of

their capital in their otherwise capital-poor environments that

motivate them to strongly resist reform.299

Public policy toward the formation and protection of capital

must clearly be refocused. The allure of low commodity prices,

resource sector development, and economic development

generally has detracted from what should be the focus of

government provision and subsidization: public goods. Conceding

that distinguishing public goods or quasi-public goods from

ordinary capital projects is difficult, I propose one guiding

principle: public goods or quasi-public goods are often network

goods. Roads and highways, railroad lines, telephone and

telecommunications networks, fiber optic cables, and the Internet

itself are all network goods.300 These goods have (or have had) the

potential to dramatically expand commerce, by providing new

means of transportation or communication. Network goods do not

merely confer positive consumption externalities301 or merely

embody complementarity with other goods,302 but rather provide

either electronic or physical linkages among users or among

nodes.303 Networks embody some public good aspects in that

there are large economies of scale involved, with marginal costs

298. Id. at 65, 70 (“Despite their lack of economic soundness and the demonstrable

damage they have done to both fish populations and fishing fleets, subsidies . . . persist in

the face of criticism. . . . Efforts to remove subsidies face tremendous political

opposition . . . .”); Michael Pollan, You Are What You Grow, N.Y. TIMES MAG. (Apr. 22,

2007), available at http://www.nytimes.com/2007/04/22/magazine/22wwlnlede.t.html?

pagewanted=all (noting that the current farm subsidy structure has been in place for the

last few decades).

299. See supra Part III.B (discussing how capital owners will fight vigorously to

protect their hoped-for stream of benefits generated by their human or social capital).

300. For a general description of network “industries,” see LAWRENCE J. WHITE, U.S.

PUBLIC POLICY TOWARD NETWORK INDUSTRIES 5–8 (1999), which describes network

industries and distinguishes between one-way and two-way networks, and Shmuel S.

Oren & Stephen A. Smith, Critical Mass and Tariff Structure in Electronic

Communications Markets, 12 BELL. J. ECON. 467, 467 (1981), which explains why a

network can be considered a “public good.”

301. A positive consumption externality is the positive effect of additional

consumption by others. See, e.g., Michael L. Katz & Carl Shapiro, Network Externalities,

Competition and Compatibility, 75 AM. ECON. REV. 424, 424 (1985).

302. See WHITE, supra note 300, at 2 (commenting on how “network industry” has

“become an expansive, all-inclusive phrase that appears to embrace almost any composite

good or service embodying complementary components”).

303. Id. (suggesting that in some network industries “there are physical or electronic

linkages that create networks”).



declining steeply with consumption.304 Networks are also

characterized by at least some degree of nonexcludability or some

degree of nonrivalrous consumption.305

I emphasize the support of network capital because the

connectivity created by networks has the potential to deliver the

kind of outsized economic benefits delivered by public goods. The

opening up of channels of commerce is perhaps the most

fundamental economic function of government.306 Commerce-

facilitating networks produce the greatest gains when they lower

the transaction costs of meeting and exchanging for persons and

entities that otherwise have no previous relationship and are in

that sense “unorganized.”307 Such a network must hold out the

promise of a fruitful exchange, so access and cost are important.

Carol Rose, in writing about the role of navigable waterways in

promoting commerce, has characterized such spaces as

“inherently public” space,308 where the costs of utilization are so

low that spontaneous, unorganized commerce can take place.

Water-based commerce represents a vital stage in the economic

development of almost every modern society.309 Similarly, the

provision of railroads, roads, highways, and the Internet each

delivered, in their own time, a crucial connectivity that opened

up entirely new sets of possible transactions, and produced

previously unimaginable gains from trading.310

304. Id. at 8–9; Michael Hsu, An Introduction to the Pricing of Electric Power

Transmission, 6 UTIL. POL’Y 257, 257–58 (1997).

305. See MITCHELL & CARSON, supra note 281, at 1 n.1. (stating that few public goods

fully exemplify the nonexcludability and nonrivalry traits); see, e.g., Brett Frischmann,

Privatization and Commercialization of the Internet Infrastructure: Rethinking Market

Intervention into Government and Government Intervention into the Market, COLUM. SCI.

& TECH. L. REV., June 2001, at 1, 25–26 (noting that the Internet is nonexcludable and

only “sometimes rivalrous”).

306. See, e.g., Carol Rose, The Comedy of the Commons: Custom, Commerce, and

Inherently Public Property, 53 U. CHI. L. REV. 711, 770 (1986) (discussing “[t]he great

commerce clause” and positing that “[t]hrough ever-expanding commerce, the nation

becomes ever-wealthier”).

307. Id. at 720–21, 765 (commenting on the role of navigable waterways in promoting

commerce).

308. Id. at 720–21, 772–73 (characterizing “inherently public property” as “fully

controlled by neither government nor private agents”).

309. See, e.g., HOUSE COMM. ON TRANSP. & INFRASTRUCTURE, supra note 284, at 27

(“Moving people and goods over water is arguably the oldest form of transportation in

human history. For millennia, civilizations have depended upon ships to move goods to

support nations and economies.”).

310. Id. at 11–13 (illustrating, for example, how a simple tee-shirt ordered in the

United States from overseas moves by truck and ocean vessel or aircraft before arriving in

the United States and being sent to the customer by freight or truck). Just as an example,

agricultural advances occurred with the expansion of crop varieties, which was made

possible by the expansion of the railroad network. GOLDIN & KATZ, supra note 56, at 265.



In the energy realm, there is one capital network worth

promoting: electricity transmission lines. The traditional

electricity paradigm of base-load power plants belonging to a

vertically integrated utility, operating as a regulated monopoly

with exclusive access to a customer base, is gradually giving

way to a deregulated, decentralized paradigm which would, in

theory, include a variety of ways for electricity supply to meet

demand.311 A deregulated and decentralized electricity supply

system would include the entry of new energy sources, demand

reduction and conservation measures, and pricing schemes

aimed at smoothing consumption patterns, thereby reducing

daily peak demands.312 Crucial in a shift to a new electricity

paradigm is the opening up of electricity markets to new

entrants, and the introduction of competition for electricity

consumers. Indeed, publicly-funded networks such as roads,

highways, and rail lines have benefited fossil fuel industries

enormously by lowering the costs of transporting fossil fuels, a

benefit that continues to afford fossil fuels an advantage over

renewable energy sources.313 To do this, a network of

transmission lines that was designed to deliver base-load

power to captive consumers must be technologically and

economically transformed.314 Care must be taken to ensure

that network goods are instruments of competition,315 as they

would if transmission lines reduce the cost of delivering

electricity and make possible a greater variety of electricity

generation sources, such as wind energy.316 Among energy

311. Cearley & Cole, supra note 192, at 170.

312. See, e.g., id. at 170, 175–76; Alexandra B. Klass & Elizabeth J. Wilson,

Interstate Transmission Challenges for Renewable Energy: A Federalism Mismatch, 65

VAND. L. REV. 1801, 1811 (2012) (discussing the challenges of wind power).

313. Alexandra B. Klass, Tax Benefits, Property Rights, and Mandates: Considering

the Future of Government Support for Renewable Energy 28 (Univ. Minn. Law Sch.,

Research Paper No. 13-11, Feb. 22, 2013), available at http://ssrn.com/abstract=222298

(explaining how the fossil fuel industry has access to a complex level of infrastructure,

such as pipelines, that is not available to other forms of energy like solar or wind energy).

314. See, e.g., Klass & Wilson, supra note 312, at 1811–12 (explaining why an

expansion of the transmission grid will be critical in order to increase the utilization of

wind resources). For a review of the complicated issues surrounding a revamping of the

electric grid, see PJM, A SURVEY OF TRANSMISSION COST ALLOCATION ISSUES, METHODS,

AND PRACTICES 3 (2010), available at http://ftp.pjm.com/~/media/documents/reports/

20100310-transmission-allocation-cost-web.ashx.

315. Severin Borenstein, James Bushnell & Steven Stoft, The Competitive Effects of

Transmission Capacity in a Deregulated Electricity Industry, 31 RAND J. ECON. 294, 295–

98 (2000).

316. Wind energy is generally abundant where people are not, such that the most

important barrier to entry for wind energy producers is access to electricity customers

through the transmission grid. See, e.g., U.S. DEP’T OF ENERGY, 20% WIND ENERGY BY

2030: INCREASING WIND ENERGY’S CONTRIBUTION TO U.S. ELECTRICITY SUPPLY 93–100



experts, energy stakeholders, and even among partisan

politicians, there is broad agreement that the U.S. electricity

transmission network dramatically needs upgrading.317

Transmission lines have many public good aspects. Regional

transmission organizations, or RTOs, which are charged with

operating most of the transmission capacity in the United States,

have become regulated utilities.318 By requiring broad access to

both electricity consumers and suppliers, which the 2005 Energy

Policy Act requires of RTOs,319 transmission lines are mandated

to assume at least one public good characteristic:

nonexcludability. Thus, the development of a cost allocation

mechanism, another thorny problem for the development of a

transmission policy,320 becomes necessary in order for RTOs to

remain economically viable.

Distinguishing capital projects worth promoting from those

not worth promoting is territory ripe for imprecision, to be sure.

However, some guidance on capital investments is surely better

than the indiscriminate, all-capital-is-good mindset embodied in

existing law and policy.

VI. CONCLUSION

This Article is the beginning of an exploration of the role of

physical, human, and social capital in perpetuating inefficient

behavior long after it is recognized as obsolete. If capital is

acquired for a very specific purpose and cannot be redeployed for

(2008), available at http://www.20percentwind.org/20percent_wind_energy_report_revOct

08.pdf.

317. ENERGY SECURITY ANALYSIS, INC., MEETING U.S. TRANSMISSION NEEDS 19

(2005), available at http://www.eei.org/ourissues/ElectricityTransmission/Documents/

meeting_trans_needs.pdf; ERIC HIRST, U.S. TRANSMISSION CAPACITY: PRESENT STATUS

AND FUTURE PROSPECTS 25 (2004), available at http://www.gc.doe.gov/sites/

prod/files/oeprod/DocumentsandMedia/transmission_capacity.pdf; U.S. DEP’T OF ENERGY,

NATIONAL TRANSMISSION GRID STUDY 5–7 (2002), available at

http://certs.lbl.gov/ntgs/main-screen.pdf; Eric J. Lerner, What’s Wrong with the Electric

Grid?, INDUSTRIAL PHYSICIST, Oct./Nov. 2003, at 8, 8.

318. See 16 U.S.C. § 796(27) (2012) (defining “RTO” for purposes of regulatory

statutes).

319. Energy Policy Act of 2005, Pub. L. 109-58, §§ 1231, 1291, 119 Stat. 594, 955,

984. North America’s electricity grid has been devolved to ten “regional transmission

organizations,” which are regulated by FERC and are mandated to play the regulated role

of an electricity transmission network. See, e.g., FED. ENERGY REGULATORY COMM’N,

REGIONAL TRANSMISSION ORGANIZATIONS MAP (2012), http://www.ferc.gov/industries/

electric/indus-act/rto/elec-ovr-rto-map.pdf.

320. Hung-Po Chao & Stephen Peck, A Market Mechanism for Electric Power

Transmission, 10 J. REG. ECON. 25, 26, 31, 39–40 (1996); William W. Hogan, Contract

Networks for Electric Power Transmission, 4 J. REG. ECON. 211, 214–15 (1992) (describing

the challenges of a cost–benefit analysis when a grid is used by many relatively small

market participants).



another purpose, then any shift in production methods could

effectively “strand” that capital and render it worthless.

Especially for mass-produced goods, such as electricity, the cost

of capital is large relative to the units in which the benefits flow

back to the owner of capital. Payback of capital is accomplished

over long time horizons, and over broad populations. When

production is undertaken with methods that involve high capital

costs and a stream of benefits that are small and widespread—

and therefore involve a long payback—a stable pricing and

regulatory environment becomes extremely important. A small

change in the pricing environment amplified over its application

to a large number of customers and transactions results in a

potentially huge change. In such an environment, owners of

capital can be forgiven for being a bit paranoid and obsessive

about protecting their capital by protecting their economic and

regulatory environment.

This Article argues that legal rules have helped capital

owners control their economic and regulatory environment to the

detriment of a broader society. Misguided policy and legal

preferences have crept into legal rules and have not only

promoted the formation of new capital, but they also protected

existing capital from regulatory interference. The problem is thus

not just that government has become an insurer against

obsolescence; it is that these legal rules insuring capital against

obsolescence have biased the mix of capital towards obsolescence-

prone capital. The result is a self-reinforcing inefficiency that

grows over time, exacerbating latent environmental problems

and making them harder to address.

This analysis takes public choice theory into new territory. A

theory of capital introduces a new variable not previously

considered carefully. The prominence of physical, human, and

social capital requires explicit treatment of actors at the

individual, firm or sub-industry levels, so as to identify incentive

structures at a disaggregated scale. This theory of capital is an

exposition of exactly what path-dependency means in the context

of industry, firm, and individual behavior. A theory of capital is a

form of institutional analysis applied to the choice sets facing

industries, firms, and individuals that engage in harmful or

inefficient behavior.

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